Historically, rapid increases in the money supply and generally liberal fiscal policy combined with stimulative monetary policy has resulted in inflation. This inflation prompts higher interest rates, which causes the market prices of existing bonds (with their fixed interest rates) to fall.
We’ve now had many years of such monetary and fiscal stimulus and yet have low inflation and still-falling interest rates. Do the old rules no longer apply? Or do they just not apply yet, and will some day hit us with a vengence?
I’ve been wrong myself in predicting a return of inflation and rising interest rates, so am giving up on predictions.
The old rule about the time lag between a change in monetary policy and the resulting impact on the real economy–whether to tighter or looser–was about eighteen months. Well, that rule is certainly out the window.
It appears that other forces that affect inflation, interest rates, and expectations are overwhelming the stimulative effect of easy money: The deep recession, deleveraging, and especially the economic weakness of the rest of the world making the dollar look relatively safe.
For those of you who believe inflation will result eventually, shorting bonds is one way to put your money where your beliefs are.
