Yep. If (more like "when") that happens, policy would then be loose and would need tightening in order to keep inflation from rising too high. Just because the current monetary policy's effects are tight doesn't mean that under other conditions they wouldn't be loose.
As somebody who was an avid reader of Krugman before I'd ever read anything from monetarists, the analogy that I had to come up with to understand why we can call current monetary policy tight even though it has gone through large expansions and easing is with the same logic that Krugman always used to explain why the stimulus was too small. He basically said something like this: while a 800B stimulus looks very expansive relative to other dollar amounts from history, relative to the 2T (or whatever it was) shortfall in GDP, it is small and arithmetically not enough to recover.
The same applies to monetary stimulus. If the economy runs at 5% NGDP and the Fed engages in policy that generally keeps it there (neither loose nor tight at that point), but then NGDP drops to -2% and in response the Fed doubles the monetary base and runs QE, which results in NGDP rise to 3% and stays there, is policy tight or loose? I don't see how the answer is anything other than "tight". The Fed may have loosened policy relative to earlier policy, but relative to the economy as a whole, it's tight. Maybe it's the wording that's throwing it off, but basically when NGDP is only 3%, it means that money is tight
No, no, no. I'll grant that it's difficult to figure out Fed policy at the moment because it is somewhat contradictory, but loose monetary policy and low interest rates go together. The Fed has direct control over only one interest rate. That is the discount rate which is what it charges for short-term loans. The discount rate greatly influences the federal funds rate which is what banks charge each other for short term loans. Obviously, a bank is going to have to charge no more than the discount rate if it expects to be able to lend money to other banks.
But the Fed does not have direct control over long term rates. However, it can influence long-term rates through its "open-market operations." It can buy long-term treasury bonds. Usually, the benchmark interest rate is the yield on the 10-year treasury bond. That's the low rate. Longer term treasury bonds and corporate bonds are likely to require a higher yield. So when the Fed buys 10-year treasuries, the price goes up and the yield goes down. That reduces interest rates pretty much all across the board. Note that this process is automatic. I can say, "The price of bonds went up," or I can say, "The yield on bonds went down." The two statements express the same thing. The one does not
cause the other. They are the same process.
But how does the Fed buy bonds? It's goes into the market and buys the bonds from the banks, and it then credits the bank's reserve account at the Fed. So if the Fed buys $100 million in bonds from a bank, their reserve account increases by $100 million. At a reserve requirement of 10%, that would enable the bank to lend out $1 billion. The current reserve requirement for most banks is about 8%.
So when the Fed buys a trillion dollars in bonds, it has expanded the
monetary base by that amount and that creates the potential for an increase in the money supply by over $10 trillion. But that hasn't happened. Why not? Because the banks were, and still are insolvent. So the point of that bond buying was to flood the banks with liquidity under the assumption that they wouldn't lend it all out. But to help encourage the banks not to, Bernanke also began paying interest on excess reserves which is something the Fed had never done before.
So what was the strategy? 1. Flood the banks with liquidity to guard against a run on the banks. 2. Buy bonds to lower interest rates and therefore push housing prices back up because much of the insolvency of the banks rests on the underwater mortgages that they are carrying. 3. Buy many of these bad mortgages from the banks at book value instead of market value to allow the banks to regain solvency more quickly. In other words, the Fed has taken these toxic assets off the banks books and added them to the Fed's books. 4. Pay interest on excess reserves to allow the banks not too lend too freely on their excess reserves and therefore avoid inflation.
It hasn't worked but that is another story. The question here is, "Is this a loose monetary policy or a tight one? Or is it in between?" I would say it is definitely a loose monetary policy because interest rates are being kept low by money creation by the Fed rather than simply due to an abundance of money due to economic growth.
The result of this is that the Fed is creating bubbles all over the place. Treasury bonds are in a bubble. Real estate is in a bubble. The stock market is probably in a bubble. Any increase in interest rates will send these assets plummeting and burst these bubbles. That is the result of "loose" monetary policy. Interest rates have been at record lows. The ten-year was as low as 1.4% at one point. That doesn't even cover the Fed's phony inflation figure so effectively it was a negative rate in real terms. It has risen by about 1% in the past year, but keep in mind that this rate is historically in the 5-6% range. So if this rate were return to something close to normal, the Wall Street banks, insurance companies, hedge funds, pensions funds, and even the Fed itself would become insolvent.
That is the effect of loose monetary policy, and it will probably be coming home to roost in the near future although what exactly will trigger the downward spiral is uncertain. But this policy is also weakening the dollar overseas. The dollar has held at about 80 on the dollar index for a long time now, but keep in mind that that is also being manipulated by the Exchange Stabilization Fund in Washington, and the time could easily come when that fund can no longer hold the dollar in the high '70's so we could see a crash there even before Wall Street goes.