Deceptive Economic Policy Tightening

The thrust of economic policy can become less supportive even if there are no changes in any policy variable if the pace of overall economic activity changes.

In the last few years, U.S. economic policies have been tightening in a deceptive manner -- not illicitly, but in a way which perhaps many have not noticed. Normally, economic policies become more restrictive because the policy variable itself – money supply growth, interest rates, the dollar, or fiscal juice – change in a manner less supportive for economic growth. For example, interest rates are increased, or the growth of the money supply weakens. However, the thrust of economic policy can become less supportive even if there are no changes in any policy variable if the pace of overall economic activity changes. Consider the impact of a 5% interest rate when nominal GDP growth is rising at 10% compared to when its growth is rising at only 5%. The interest rate may not have changed, but its impact is much more contractionary when the economy is growing at 5% compared to when it is surging at 10%.

In simplistic terms, the interpretation of economic policy has been complicated in recent years because the pace of overall economic growth has varied so widely since the Covid pandemic. In 2021, the annual growth in nominal GDP surged above 17% -- its strongest annual pace of growth since the 1950-51 period. Since its 2021 peak, annual GDP growth has steadily declined back to 5% as of the third quarter 2024. The change in economic growth from above 17% to only 5% in just three and one-half years is something the U.S. has not dealt with since the early-1950s. Indeed, since 1990, the strongest annual growth rate in nominal GDP was 7.6% and the annual pace of GDP growth spent most of its time below 6%. Economic expansions since 1990 were characterized by relatively consistent nominal GDP growth ranges during expansions. That is, when evaluating how contractionary economic policy was at any point, the pace of economic growth was not much of a consideration.

In the contemporary era, however, the pace of overall economic growth is playing a much larger role and should not be dismissed when assessing the efficacy of economic policy. It’s worth examining just how tight overall economic policy currently is considering the overall growth of nominal GDP has persistently slowed. What follows is a quick pictorial and some thoughts regarding the current contractionary position of each major economic policy – monetary growth, bond yields, the dollar, and fiscal stimulus.