This article originally appeared on the National Review on March 19, 2021.
Considered an indicator of investor confidence, the ten-year Treasury bond yield has risen rapidly by about 0.7 percent since the beginning of the year. Many experts credit the rise to expectations for substantially higher inflation. Yet this view is overly simplistic and hasty. The recent increase in returns on ten-year Treasuries has more to do with the improving U.S. economic outlook and with real interest rates rising than it does with inflation. There are certainly inflationary risks on the horizon, but it would be a mistake for the Fed to act prematurely.
The risk of the Fed signaling or tightening policy too soon are substantial. As Milton Friedman and Anna Schwartz famously pointed out in A Monetary History of the United States, the Fed exacerbated the Great Depression by contracting the money supply. In 2019, we argued at the Wall Street Journal that the Fed made a mistake in raising interest rates too much in 2018 — and the central bank cut rates shortly after our article was published in 2019. We similarly worry that inflation hawks may be prompting the Fed to repeat that mistake.
Movements in interest rates reflect a number of factors, but the two more prominent are expectations about the future path of economic growth and the future path of inflation. If economic expectations are driving an increase in rates, we should be celebrating rather than worrying about inflation. Sure, rising interest rates will cause some short-term pain in the stock market (much like they did following the Great Recession), but the stock markets will recover after pricing in new discount rates.
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