As long as we’re talking about market monetarism and Scott Sumner, he’s got an interesting post about the relationship between long-term interest rates and the Fed’s asset purchases. Cue Sumner:
These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
Nope. Long term yields increased on the news, just as market monetarist’s would have expected. And thank God they did! The higher yields are an indication that markets have (slightly) raised their NGDP forecasts going forward.
Here’s the thing. I come at these debates from the perspective of a former market participant, not an economist. So the simplest reason why people assume the Fed is pushing down rates with its asset purchases is that, when new buying pressure comes into the market, the clearing price of an asset goes up (and, by definition, its yield goes down). So if the Fed starts buying billions of Treasuries, and nobody else’s preferences in the market change, you’d expect yields on Treasuries to go down.
For the clearing price to go the other way, market participants would need to anticipate that, at the same price at which the Fed was willing to buy, more participants would want to sell – precisely because the Fed was buying, and intended to continue buying (since that is the only new market information).
Now, long rates are one very good proxy for longer term nominal growth expectations, so this all makes logical sense on one level. And, as Sumner notes, it’s what happened this time. But you can see why it’s not intuitive that the effect of Fed buying is to induce a larger, more-than-offsetting volume of selling, and hence to push yields up to find the new clearing price.
Sumner is basically explaining that a Fed commitment to open-ended QE means, “we’re going to keep buying bonds until we’ve driven the price of bonds down enough.”
Which, again, when you work through it isn’t actually crazy. But it’s pretty weird.