“After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.”
–Milton Friedman, “Reviving Japan[1],” 1998
In this article, I want to take a deeper look at a very common misconception about interest rates, namely that low rates are a sign of easy money and stimulus. This misguided belief can lead people to make incorrect assessments about inflation and, hence, their investment thesis. Today, we cover the “interest rate fallacy.”
A large part of the inflation story drilled into us by the negligent economists in academia and at the Federal Reserve is the belief that low rates lead people to borrow more and expand credit, aka, print money. They want us to believe that the Fed sets rates low as an easy money policy to cause growth and inflation. On top of this, they have built the idea that low rates plus quantitative easing (QE) is very inflationary, as if they are unleashing a biblical flood of liquidity and money printing.
All schools of thought that I’m familiar with agree that low rates are stimulatory: Classical, Keynesian, Monetarist and even my beloved Austrian School. It’s a nearly-universally held dogma that is objectively wrong.
Milton Friedman And The Interest Rate Fallacy
The interest rate fallacy was outlined by Milton Friedman all the way back in 1968, in “The Role Of Monetary Policy,” published by The American Economic Review. He wrote this prior to the Nixon Shock, when the U.S. was still on a gold standard, but the monetary system was already working as if
