What’s the reference point for the term “tighten/loosen monetary policy stance”?

Genevieve Signoret

(Vea la versión en español de esta entrada.)

In a recent Twitter discussion, I answered the following query by Ricardo Medina (@ideasalvuelo) (I translate from Spanish): If a central bank holds its monetary policy rate steady while most other central banks lower theirs, has the local central bank tightened its policy stance?

Si un Banco Central mantiene su tasa de referencia y los demás (mayoría) Bancos Centrales las disminuyen, ¿endureció su postura monetaria?

— Ricardo Medina (@ideasalvuelo) August 15, 201

I answered “No.” I explained that the convention is to use the terms “tighten” or “loosen” central bank policy stance with respect to the same bank’s prior stance, not to the dynamics of (synchronic or recent policy changes by) central banks around the world.

I did mention that in the circumstances Ricardo describes, the local currency may appreciate. Currencies are thought to appreciate in nominal terms when local nominal interest rates go up relative to rates available elsewhere, as investors seeking interest income increase their demand for local-currency–denominated interest bearing assets.

Yesterday, however, upon reading across a blog entry by Marc Chandler at Also Sprach Analyst on the Bank of England’s MPC minutes, I ran across this:

Since the middle of last year, sterling has appreciated almost 9% on the BOE’s broad-trade weighted measure. This is tantamount to some degree of tightening.

My immediate thought was that my answer to Ricardo on Twitter had been too simplistic. So let me now retry, with more nuance.

Suppose that other central banks ease but yours stays the same and that this does lead to nominal currency appreciation via purchases by foreign investors of the local currency with which to buy local-currency interest income producing assets. This removes local currency from circulation, in this sense “tightening” the monetary policy stance.

Summarizing: I hold to my answer that standard usage of the term “tighten” refers to a change in a policy variable with respect to that same variable’s prior value, not with respect to changes occurring outside the currency area. However, I add to that answer the observation that monetary policy decisions, including the decision not to change any policy levers, can drive nominal exchange rates such that, post hoc, the original decision can be said to be “tantamount to tightening”.