The Fed “Succeeded” in Flattening the Yield Curve

Some articles point out one “bright spot” in this dismal day—the Fed succeeded in lowering long term yields.  They also raised short term yields, making the yield curve flatter.  You might want to get out your money textbook to find out what type of monetary policy causes a flatter yield curve.  According the an article by Sharon Kozicki at the Kansas City Fed:

The yield spread reflects the stance of monetary policy. According to this view, a low yield spread reflects relatively tight monetary policy and a high yield spread reflects relatively loose monetary policy.

The yield spread is the long rate minus the short rate.  Kozicki says the conventional view is that a lower yield spread means tighter money.  Today the Fed made the yield curve flatter.  You might think; “They know what they are doing; surely they wouldn’t tighten monetary policy.  Sumner must have things backward.”

OK, how would tight money affect the dollar?  Here’s the euro/dollar (the fall means the dollar soared after 2:15, or 6:15 London time):

And here’s the Dow:

So what do you think, monetary stimulus or monetary tightening?  The only thing that’s “twisted” is the Fed’s logic.  They are so obsessed with the Keynesian low interest rate approach to stimulus that they’ve completely lost their bearings and ended up tightening monetary policy.

PS.  I forgot to mention one other piece of “good news,” the Fed action sharply reduced oil prices.  Less inflation “worries.”

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About Scott Sumner 492 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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