Janet Yellen’s Speech on Policy Rules

For many years, going back to the days before Google and Google Scholar helped us find and keep track of things, I created a monetary policy rule home page with links to papers, articles and speeches on policy rules, including a written version of a 1996 speech by Janet Yellen on the Taylor rule.

Janet Yellen’s  speech is one of the clearest, most sensible, and most supportive analyses ever written about the Taylor rule.  I strongly recommend reading it, especially pages 4 to 11, in light of the recent congressional interest in policy rules.  She describes the rule, and then she carefully discusses “several desirable features” it has “as a general strategy for conducting monetary policy.”

She says that “the framework of a Taylor-type rule could help the Federal Reserve communicate to the public the rationale behind policy moves, and how those moves are consistent with its objectives.”  She mentions that she is “certainly not proposing the mechanical use of the Taylor rule.” And she adds correctly that “Nor would Taylor himself.”  She indicates that more work should be done to improve on such rules, and that in certain circumstances, which she describes, there could be deviations from the rule.

So one cannot help but be amazed by the exchange of views on the Taylor rule or rules in general between Janet Yellen and Richard Shelby, Chair of the Senate Banking Committee on Tuesday, and between her and Jeb Hensarling, Chair of the House Financial Services Committee on Wednesday.  In many respects, her speech makes the case for using monetary policy rules in the way that is called for by the policy rules bill that Shelby and Hensarling were asking her about and she seemed to be objecting to.  Some observers indicated that they seemed to be talking past each other.  But at the least there should be some common grounds for agreement that could form the basis for progress going forward.

Posted in Monetary Policy

A Feature Not a Bug in the Policy Rules Bill

In his opening line of questions for Janet Yellen at the Senate Banking Committee today, Senator Richard Shelby asked about the use of monetary policy rules and the Taylor Rule, apparently referring to the recent policy rules bill (Section 2 of HR 5018) that would require the Fed to report its strategy or rule for policy. The headline-grabbing first sentence of Janet Yellen’s  response was about not wanting to “chain” the FOMC to a rule, and it did get a lot of attention (including many real time tweets). But it was the rest of her response that really focused on the Senator’s question. Here is a transcript from C-Span (minute 28:39).

SENATOR SHELBY: YOU HAVE OPINED ON THE USE OF MONETARY POLICY RULES SUCH AS THE TAYLOR RULE, WHICH WOULD PROVIDE THE FED WITH A SYSTEMATIC WAY TO CONDUCT POLICY IN RESPONSE TO CHANGES IN ECONOMIC CONDITIONS. I BELIEVE IT WOULD ALSO GIVE YOU — GIVE THE PUBLIC A GREATER UNDERSTANDING OF, AND PERHAPS CONFIDENCE IN, THE FED’S STRATEGY. YOU’VE STATED, AND I’LL QUOTE, RULES OF THE GENERAL SORT PROPOSED BY TAYLOR CAPTURE WELL OUR STATUTORY MANDATE TO PROMOTE MAXIMUM EMPLOYMENT AND PRICE STABILITY. YOU HAVE EXPRESSED CONCERNS, HOWEVER, OVER THE EFFECTIVENESS OF SUCH RULES IN TIMES OF ECONOMIC STRESS. WOULD YOU SUPPORT THE USE OF A MONETARY POLICY RULE OF THE FED’S CHOOSING IF THE FED HAD DISCRETION TO MODIFY IT IN TIMES OF ECONOMIC DISRUPTION? >>  CHAIR YELLEN: I’M NOT A PROPONENT OF CHAINING THE FEDERAL OPEN MARKET COMMITTEE IN ITS DECISION MAKING TO ANY RULE WHATSOEVER. BUT MONETARY POLICY NEEDS TO TAKE ACCOUNT OF A WIDE RANGE OF FACTORS SOME OF WHICH ARE UNUSUAL AND REQUIRE SPECIAL ATTENTION, AND THAT’S TRUE EVEN OUTSIDE TIMES OF FINANCIAL CRISIS. IN HIS ORIGINAL PAPER ON THIS TOPIC, JOHN TAYLOR HIMSELF POINTED TO CONDITIONS SUCH AS THE 1987 STOCK MARKET CRASH THAT WOULD HAVE REQUIRED A DIFFERENT RESPONSE. I WOULD SAY THAT IT IS USEFUL FOR US TO CONSULT THE RECOMMENDATIONS OF RULES OF THE TAYLOR TYPE, AND OTHERS, AND WE DO SO ROUTINELY, AND THEY ARE AN IMPORTANT INPUT INTO WHAT ULTIMATELY IS A DECISION THAT REQUIRES SOUND JUDGMENT.

Note how Janet Yellen refers to my 1993 paper where I pointed to the 1987 stock market break as a case where there was a deviation from the Taylor rule. However, this example is really an illustration of how the policy rule legislation would work effectively rather than a critique of the legislation. To see this, take a look at this chart from my original paper:

fig 1 of taylor 1992

 

Notice how the funds rate was cut in 1987 while the policy rule setting kept rising.  This is the deviation that Janet Yellen was referring to.  It is actually quite small and temporary, but in any case the Fed could easily take such an action and stay within the terms of the policy rules bill.  The Fed chair would simply explain the explicit reason for the deviation as required in the legislation. I can’t imagine the case would be difficult to make given the size of the shock unless for some reason the deviation continued long after the shock.   This example illustrates a feature not a bug in the bill

Posted in Monetary Policy

A Review of Recoveries in Contrast

I’ve been tracking the economic recovery with charts and commentaries on this blog since it began in 2009. The simplest but most revealing charts compared and contrasted this recovery with the recovery of the 1980s. Here’s an update of two of those charts. The first shows the change in the employment-to-population ratio,emptopop-1-2015

and the second shows the growth rate of real GDP for the two recoveries.

80sgrowthcomp-2014-4

One can’t help but notice the enormous difference back at the start of this recovery, but the difference has persisted year after year for going on six years now.

At the time of the first anniversary of current recovery in 2010, it showed clear signs of weakness compared to the recovery from the recessions in the early 1980s and from all other deep recessions in American history. Some said it was a natural occurrence because of the depth of the recession, but Milton Friedman long ago showed that there was nothing natural about it.

By the recovery’s second anniversary in 2011, it was weak for long enough that I called it “a recovery in name only, so weak as to be nonexistent.” Still some said it was not so bad given the depth of the recession, but research by Mike Bordo and others verified that something unusual was going on.

By the recovery’s third anniversary in 2012, it was now the worst recovery from a deep recession in American history.  Some still disputed that but an analysis of the data in these charts showed we clearly had a problem on our hands. In my view the problem was economic policy and I wrote First Principles to explain that view.

By the recovery’s fourth anniversary in 2013, few disputed any more that it was unusually weak and disappointing.  But rather than consider government policy as the cause, other explanations arose, such Larry Summers’ “secular stagnation” (see Chapter 2 of Baily-Taylor) which took the economic commentary world by storm.

By the recovery’s fifth anniversary, we were so far away from the recession that linking the terrible performance to the recession became increasing far-fetched.  The sarcastic sounding “not-so-great-recovery” had become a favorite label, and the “it’s policy” versus “it’s secular” debate continued.

With the recovery now approaching its sixth anniversary, there is more optimism that we are finally coming out the excruciating slow growth. There is also some wishful thinking that the drop of people out of the labor force—which has made the unemployment rate come down—is due to demographic factors not the slow growth itself. And we are not as bad as Europe.

But as these charts show there is still not much in this recovery to write home about. Growth over the four quarters of 2014 looks to average only 2.2% compared with 4.4% in the corresponding quarters of the 1980s recovery. And as of January 2015 the employment-to-population ratio is still lower than at the start of the recovery.

Posted in Slow Recovery

It’s Not About Conspiracy Theorizing, It’s About Effectiveness

Yesterday Paul Krugman took some pot shots at an op-ed that Paul Ryan and I wrote nearly five years ago—an op-ed that was critical of quantitative easing. Here’s why Krugman missed his mark and the QE critics are correct.

The op-ed stated that QE1—the 2009 actions “in which the Fed bought not only large amounts of Treasury securities but also securities backed by private mortgages”—“failed to strengthen the economy.” Krugman claims that the only evidence we had at the time was that the economy did not strengthen. As he puts it, “when I stepped outside this morning, it was cold, so I put on a coat — but it didn’t work, because it was still cold.” But there was and is evidence, including econometric research by Johannes Stroebel and me completed in 2010–later published in the International Journal of Central Banking–and basic finance theory as explained by John Cochrane in an interview published in Econ Focus by the Richmond Fed.  A short summary based on my research of the role of monetary policy in the crisis is found here. It is critical of monetary policy before and after the panic in the fall of 2008, but not during the panic.

The op-ed also said that an upcoming round of “QE2 will create more economic uncertainty, stemming mainly from reasonable doubts over whether the Fed will know exactly when and how to contract its balance sheet after such an unprecedented expansion” and that these quantitative easing operations “involved the Fed in areas of fiscal policy, such as credit allocation,” arguing that such operations were the proper role of Congress.  Here Krugman simply resorts to the accusation that the article engaged “conspiracy theorizing.” This is way off. There was no mention of individuals, no mention of conspiring or even talking with other people in the op-ed.  The concern clearly expressed in the oped was about the loss of central bank independence and the departure from rules-based policy—a concern expressed by many people then and now—not that there was a conspiracy.

Krugman also criticized once again a letter written on 2010 criticizing quantitative easing. I responded to that criticism here.

Update: Krugman put material from his blog post of yesterday into his  NYT column today, so my response in this blog pertains to that column too.

Posted in Monetary Policy

Paul Krugman Pontificating on Policy Rules

In a recent blog post Paul Krugman talks a lot about policy rules and the Taylor rule in particular.

He complains that “Republicans are pushing to mandate that the Fed follow the so-called Taylor rule.”  But the policy rule legislation that has come out of Congress recently would simply require the Fed to describe a rule or strategy of its own choosing, not follow any specific rule.  The legislation refers to a policy rule that I invented, but simply as a “reference rule,” not a “mandated rule.”   Fed officials have been referring to that rule for many years as a benchmark, or as an example, or simply as a framework to argue for change, such as a lowering of the equilibrium real interest rate in that rule. Such references reflect standard practice for the Fed.

Krugman talks about the history of the Taylor rule.  He does not dispute that monetary policy was well described by that rule during the good economic performance period of the Great Moderation. And he does not dispute that policy departed from that rule during the pre-crisis period leading up to the end of the Great Moderation. Rather he claims that the departure was slight and, according to some models, not enough to cause a deterioration of economic performance.  But the departure was not slight; it was as large as the deviations during the 1970s when economic performance also deteriorated. And there are plenty of empirical studies that connect that departure to a deterioration in performance,  including the work on monetary policy and the housing boom and bust I presented in Jackson Hole in the summer of 2007 and the work by Jarocinski and Smets and Ahrend.

Historical research showing that a more rules-based policy works better than pure discretion is vast, much of it reviewed in a recent issue of the Journal of Economic Dynamics and Control. “I think it is important, based on my own experience, to have a rules-based monetary policy,” writes former Secretary of Treasury, George Shultz in the volume.  And monetary historian Allan Meltzer concludes that “The main lesson of this trip through history is that following a rule or a quasi- rule…produced two of the best periods in Federal Reserve history.”  Michael Bordo states that “The Fed has moved away from rules policy in its lender of last resort function,” and “this policy shift contributed to moral hazard and created new threats to financial stability.”

Krugman talks about the zero interest rate bound and the Taylor rule. He claims that the zero bound on interest rates was considered too minor to incorporate in work on policy rules. But the bound was explicitly taken into account in my research work that led to the Taylor rule.

Krugman opines that people are “inventing ever-more bizarre stories to avoid admitting having been wrong about something,” the Taylor rule in particular. Yet my 2007 paper was completed before the start of the Great Recession, and empirical macroeconomists, such as David Papell and his colleagues, are carefully reviewing the same old policy rule story not inventing new bizarre stories.

Krugman offers a funny video of Woody Allen to illustrate his piece. Funnier would be the famous “You know nothing of my work,” clip from Annie Hall.

Posted in Monetary Policy

Reply to Alan Blinder Redux

Alan Blinder has written another Wall Street Journal article criticizing legislation that would simply require the Fed to describe its rule or strategy for monetary policy.  As with his earlier article, Blinder still “shoots at a straw man of his own making, not at the proposed law itself” as I wrote in another John Taylor’s Reply to Alan Blinder for the Wall Street Journal.

Blinder says the act “would require the Fed to adopt a mechanical rule for monetary policy.”  No, there is nothing mechanical about what is required. The legislation emphasizes that it is the Fed’s job to choose the rule and to describe the rule, and it can do so as it sees fit.

Blinder sounds particularly upset that the legislation, as he puts it, “strongly suggests a rule invented by economist John Taylor of Stanford University.”  While a policy rule invented by me is referred to in the legislation, it is simply put forth as a “reference rule,” not a “required rule,” not a “preferred rule,” and certainly not as a “strongly suggested rule.”

It is hard to find work done on monetary policy rules that does not refer to the Taylor rule in some way. Such references have been made by Fed policymakers and staff for decades, both internally and externally.  Referring to such a rule as a benchmark, as an example, or even as an alternative is standard practice for the Fed, so having the Fed refer to this “reference rule” is by no means a warning to “Depart from the Taylor rule at your peril” as Blinder cutely puts it.

Blinder admits that “As rules go, the Taylor rule is not a bad one. In normal times, it provides a useful benchmark against which monetary policy can be appraised.” He then adds:  “But what about abnormal times? When the economy departs from ‘the rules,’ do we really want the Fed to stick with the Taylor rule out of fear of congressional browbeating?”

But the legislation is explicit that the Fed can depart from its chosen rule; all it needs to do is explain the reasons for the departure.  Such an approach will increase transparency not increase browbeating.

Posted in Monetary Policy

A New Fed Centennial Volume with a Twist

As the two year centennial of the founding of the Fed in 1913-14 draws to a close this month, a new centennial volume, Frameworks for Central Banking in the Next Century, is being published as a special issue of the Journal of Economic Dynamics and Control. Edited by Michael Bordo, Bill Dupor and me, the volume consists of papers, discussions and panelists’ remarks from a conference at Stanford’s Hoover Institution. The overall viewpoint of the volume is considerably different from other centennial volumes, including a symposium published by the Journal of Economics Perspectives called The First 100 Years of the Federal Reserve, based on a conference held at the National Bureau of Economic Research.

As Mike Bordo and I explain in the introduction to the new volume “…the findings are consistent with, and would encourage, a more rules-based policy for the Federal Reserve. As a result they would, as many of the papers argue, improve economic performance in the United States and the global economy.”  For example, the first paper (presented at the conference by David Papell) “uses a battery of statistical techniques to determine when in history monetary policy was rule-like, and it shows that the rule-like periods coincide remarkably well with periods of good economic performance. A clear policy recommendation emerges directly from these statistical findings: use rules-based monetary policy whenever you can.” (This introduction and all the papers in the volume can be found here).

There are, of course, discussions and debates on this and many other important central banking policy issues elsewhere in the volume with fascinating contributions by John Cochrane, Lee Ohanian, Michael Bordo, Athanasios Orphanides, Rich Clarida, Alex Nikolsko-Rzhevskyy, Ruxandra Prodan, Andy Levin, Marvin Goodfriend, Esther George, Tom Sargent, Monika Piazzesi, Charles Plosser,  John Williams, Jeff Lacker, Ed Prescott, Allan Meltzer, Niall Ferguson, Martin Schneider, Maury Obstfeld, Barry Eichengreen, George Shultz and Otmar Issing.

Here is what the special issue (with the TOC on the back cover) looks like. JEDC Dec 2014_Page_1Interestingly, 35 years ago (when the rational expectations-policy evaluation revolution was just beginning) I coedited (with Matt Canzoneri) another special issue of the JEDC on aspects of rules-based policy with contributions by Sargent, Prescott, Kydland, Hansen, Calvo, Chow, Fischer and me.  Here is what it looked like.

JEDC Feb 1980

Posted in Monetary Policy