Great news on the inflation front: According to the Bureau of Economic Analysis, price pressures have significantly eased. The Personal Consumption Expenditures Price Index (PCEPI) rose 3.0 percent year-over-year in October, down from 3.4 percent the month before. Continuously compounded, headline inflation was a mere 0.59 percent last month. Core inflation, which excludes volatile food and energy prices, was 1.96 percent. Even the higher number is below the Federal Reserve’s  2.0 percent target. We could be near the end of the war on inflation.

Many financial and economic commentators doubt the Fed will tighten monetary policy further in December. The latest release would seem to reinforce their doubts. Ongoing disinflation means monetary policy is unambiguously tight. To see why, consider the two most common barometers of monetary policy: interest rates and the money supply.

The current target for the federal funds rate, which is the Fed’s key policy interest rate, is between 5.25 and 5.50 percent. Using core PCEPI growth, the inflation-adjusted range is 3.29-3.54 percent. As always, we must compare this to the natural rate of interest. Sometimes called r* by economists, this is the inflation-adjusted rate consistent with maximum employment and output, as well as non-accelerating inflation. We can’t observe this rate directly. But we can estimate it. Widely cited figures from the New York Fed place r* between 0.57 and 1.19 percent. That means current market rates are roughly three times as high as the estimated natural rate! This is likely an overstatement, since the New York Fed’s data only goes through 2023:Q3 and many believe the natural rate has ticked up in recent months. Nevertheless, judging by interest rates, monetary policy is clearly restrictive.

Money supply data tell us more of the same. M2, arguably the most important measure of the money supply, is down 3.30 percent from a year ago. We should also consult broader aggregates that weight money-supply components based on how liquid they are. These figures are shrinking between 1.73 percent and 2.62 percent per year. While it is not unusual for the stock of money to grow more slowly, it is highly unusual for it to fall. Unless the demand to hold money is falling even faster (which is incredibly unlikely), this is evidence for tight money.

The Fed will probably keep the fed funds target range unchanged in December. Officials previously signaled additional tightening, but things have changed. Central bankers can read the macro data just as easily as we can, and financial markets have been clamoring for lower rates. 

Fed followers sometimes get whiplash. Discretionary monetary policy is inherently unsteady, like trying to cross a canyon on a tightrope. Loosen too much relative to market expectations and you get crippling inflation; Tighten too much relative to market expectations and you get a painful downturn. Fed decision makers must always be searching for the “sweet spot.” A strict rule for monetary policy would be better, but as long as we must live with discretion, we should hope it’s wielded as responsibly as possible.