Due to previous commitments in Hong Kong I could not attend today’s Bretton Woods: The Founders and the Future conference in New Hampshire, but I was invited to speak via video. Here is the text of my remarks.

I want to thank Larry Goodman for hosting this timely conference in Bretton Woods, and for giving me a chance to give some remarks.  In my view the time is ripe for a new international understanding, and perhaps even agreement.  It is good, for example, that IMF is revising its exceptional access framework in light of the unpleasant experiences of the recent European sovereign debt crisis.

But I want to focus today on the international aspects of monetary policy.  Soon after the end of the Bretton Woods system in the 1970s, monetary economists—myself included—started to use their brand new Keynesian models with rational expectations and price rigidities to examine how monetary policy should be conducted in a world of flexible exchange rates. They found two surprising things.

First, they found that simple steady-as-you-go, rule-like monetary policies would lead to a NICE outcome—that is a non-inflationary consistently expansionary, N-I-C-E, or NICE  outcome to use the term coined by Mervyn King.

Second, on the international side and even more surprising, they found that those same steady-as-you-go, rule-like monetary policies would also achieve most of the potential gains from international cooperation of monetary policy. And this would occur even if each central bank focused on its own country’s economic performance.  In other words the international monetary system would be NICE: near an internationally cooperative equilibrium, N-I-C-E, or NICE. One could say that the NICE system would help the world economy stay together during the NICE period.  Let’s just call it NICE-squared.

What is even more surprising is that the actual outcome in the years that followed—the  1980s, 1990s and until recently—seemed to bear out these NICE-squared predictions. As central banks moved toward more transparent, rules-based monetary policies—including through inflation-targeting—economic performance improved dramatically, especially compared with the 1970s, and an important step was when the Fed began to announce its federal funds target.

By choosing policies which worked well domestically, central banks contributed—in “invisible hand” like fashion—to better global economic conditions during this NICE-squared period. And toward the later part of this period, central banks in many emerging market countries began to move toward more rule-like policies.  As they did so, they began contributing positively to overall global monetary stability.

But during the past decade—especially since the end of NICE-squared—international spillover effects have again become a major policy issue.  Policy makers in emerging market countries from Brazil to India complain about adverse spillover of monetary policy in the US.   Policy makers in developed countries including Japan and Europe have pointed to the adverse exchange rate effects of monetary policies in the US and some have raised concerns about currency wars and competitive devaluations.  Many central banks—from Singapore to Switzerland—have been forced into near-zero or too-low-for-too-long policy rates have had to take actions, euphemistically called macro-prudential to prevent the booms and busts in housing or consumer durables markets.

What caused the end of the Nice-squared? Some say it was the financial crisis itself. Others say that international capital flows have exogenously become more volatile.

But the more obvious explanation is that monetary policy deviated from steady-as-you-go, rule-like policies of the NICE-squared period. Empirical research shows that such deviations in the United States and some other countries started about a decade ago when interest rates were held very low.  Researchers at the OECD and the BIS have detected a similar Global Great Deviation which is continuing to the present—especially when the large-scale unconventional central bank interventions are included.

So the implication is that we should try to go back to the steady-as-you-go, rule-like policies that worked in the NICE-squared period.  An international understanding and agreement will help. Such an agreement could instruct the IMF or the BIS, or even ask private non-profit groups, to monitor the extent to which central bank policies are steady and rule-like.

But will it be enough?  I think so.  The large destabilizing monetary-policy-induced capital flows motivated by search for yields would diminish. Fear of free falling exchange rates would be calmed as reliable central bank actions come to be expected.

A NICE-squared world would reappear. At least that is the hope and purpose of a conference like this. Thank you very much.

Notes: The first reference to “NICE” is from Mervyn King, Stamp Memorial Lecture, London School of Economics, October 2012; the term “Global Great Deviation” is from Boria Hofmann and Bilyana Bogdanova, “Taylor Rules and Monetary Policy: A Global Great Deviation?” BIS Quarterly Review, September 2012;  the term “fear of free falling” is from Carlos Vegh and Guillermo Vuletin, “Overcoming the fear of free falling: Monetary policy graduation in emerging markets,” NBER Working Paper No. 18175, June 2012.

Posted in International Economics

Family Economics and Macro Behavior at a Gary Becker Memorial

Kevin Murphy and I were invited to speak at a memorial session for Gary Becker at the Mont Pelerin Society meetings in Hong Kong yesterday.  My remarks focused on the time Gary spent each year at the Hoover Institution and on his foray into presidential politics, much like I wrote in this post, but I also was asked to delve into macro which is quite interesting

Gary wrote several good papers on macro back in the 1950s. In a 1952 paper with William Baumol, coming out of his undergraduate days at Princeton, Gary defended the classical economists showing that they were not nearly as naïve as Lange and Keynes claimed.  Then in a 1957 paper with Milton Friedman, he criticized empirical tests of the Keynesian consumption function, and followed up a year later with a reply to Lawrence Klein who reacted angrily to the criticism.

Most interesting was his 1956 “A Proposal For Free Banking,” a short paper which remained unpublished for 37 years, though Friedman referred to it in his famous 1960 Program for Monetary Stability.  Gary was reacting to the 100% reserve requirement proposal then popular at the University of Chicago, arguing that the banks were already too regulated.  He did recommend that the government maintain a monopoly on printing notes, because he was worried about an indeterminate price level.  While banks could issue checking deposits, holding reserves as needed to deal with currency demand, he argued that the need to convert to cash would lead to a finite amount of deposits and a determinate price level and that shifts in the currency deposit ratio would not be that great and could be stabilized.

No discussion of Gary’s contributions to macro would be complete without considering his Presidential address to the American Economic Association in Chicago in 1987.  I was at the talk and recall being surprised that he decided to concentrate on macroeconomics. He titled the talk “Family Economics and Macro Behavior.”  And he covered the gamut of the subject.

He was positive about the neoclassical growth model’s advances over the Malthus, but he criticized it for leaving out sustained growth in income per capita. As Becker put it, “The persistent growth in per capita incomes during the past two centuries is no easier to explain within the neoclassical framework than within the Malthusian” and the need to rely on “exogenous progress is a confession of failure to explain growth within the model.”  The neoclassical modelers were right to stress endogenous capital accumulation and the Malthusians were right for stressing fertility responses, he argued, but then went on to discuss the importance of adding the family to economic growth and traced out a model “combining the best features of the neoclassical and Malthusian models” in which parents choose both the number of children and the human capital bequeathed to each child, motivated by parental altruism or love toward children. “Altruism means that the utility of parents depends on the utility of each child,” an idea, once conceived, that was easy to work into the algebra.  So he added family economics to the Solow growth model simply by letting the parent’s utility function depend on the utility of the children.  This changed the results in important ways. In the event of a deep recession, a temporary decline in productivity could permanently lower aggregate income because of the decline in birth rates.

And it had other implications. He pointed out, referring to Robert Barro, that a “dose of family economics radially alters traditional conclusions about the effects of budget deficits on private saving” because “Parents offset any increase in future taxes with a greater bequest, and thus there is no effect on consumption. “ He then showed that this Ricardian equivalence result could be reversed if Social Security reduces the demand for children.

Becker also criticized the overlapping generation models because they did not include familial connections.  In his view the lack of connections between children and parents, husbands and wives and other members of the family led these models to focus on minor problems. He particular criticized the models as ways to justify the demand for money, as Sargent and Wallace had done. He argued that in both modern and ancient times, “children have been an important resource and money balances an unimportant resource of the elderly in practically all societies, whether simple or complex.”

Regarding shorter run cycles, Gary had to admit that none of the modern macroeconomic theories relied much on family behavior to cause business cycles, but he did mention that Hansen’s secular stagnation concept related to declining population growth, which could have been an endogenous response to the great depression.

Many of these family economics ideas are now an integral part of the macro mainstream. In fact in the latest edition of the Handbook of Macroeconomics Harald Uhlig and I are including a chapter on “Family Macroeconomics” by Matthias Doepke and Michele Tertilt and another paper on “The Macroeconomics of Time Allocation” by Mark Aguiar and Erik Hurst.


Baumol, William J. and Gary S. Becker (1952), “The Classical Monetary Theory: The Outcome of the Discussion,” Economica, New Series, Vol. 19, No. 76. Nov, pp. 355-376.

Becker, Gary S. (1956), “A Proposal for Free Banking,” published later with a new introduction in L. H. White (Ed.) (1993) Free Banking, Aldershot, U.K.: Elgar, 1993, pp. 20-25

Becker, Gary S. and Milton Friedman (1957), “A Statistical Illusion in Judging Keynesian Models,” Journal of Political Economy, Vol. 65, No. 1, Feb. pp. 64-75

Becker, Gary S. and Milton Friedman (1958), “The Friedman-Becker Illusion: Reply” The Journal of Political Economy, Vol. 66, No. 6, Dec. pp. 545-547

Becker, Gary S. (1988), “Family Economics and Macro Behavior,” The American Economic Review, Vol. 78, No. 1, Mar., pp. 1-13.

Posted in Teaching Economics

Terminal Policy Rates: Hot, Cold and About Right

Last week I flew overnight from Cartagena, Colombia (90o F, very humid) to Jackson Hole, USA (37o F, plus wind chill). In both places I was asked a lot about monetary policy—by bankers at the conference in Colombia and by central bankers at the conference in the US. The most common question was “What is the real equilibrium policy interest rate?”  Is it 2% as in the original Taylor rule, or is it 0%, (Taylor rule minus 2) as the people at PIMCO (Paul McCulley and Bill Gross) have been arguing, or is it even negative as the new secular stagnationists such as Larry Summers would have it.

FOMC members have expressed their views on this for a while, with a median of around 4% nominal, which translates into 2% real if you use their 2% target inflation rate.  Recently their median is slightly lower, 3-3/4 %, and that is also what former governor Larry Meyer at Macroeconomic Advisers is saying, though this is still not much different from 4%.

Paul McCulley admits befuddlement by all this and is making the case for a change.  In a recent PIMCO newsletter he says “…for me, it is so befuddling that the Fed, and thus the markets, still clings – even if reluctantly – to one man’s estimate of an “equilibrium” real fed funds rate, made in 1993: John Taylor, who assumed it to be 2%….I’ve got to hand it to John, whom I’ve known and liked for a very long time: Twenty-one years on, and you are still hardwired into the catechism of Fed policy!”

Well there are other plenty of other catechism type “questions-and-answers” that are not hardwired, though I wish they were, such as “Q: Should the Fed adopt and state a rule or strategy for the instruments of monetary policy? A:Yes”

I have not seen convincing evidence of a new neutral for the terminal federal funds rate in a policy rule.  The 2 percent real rate was chosen back when the potential economic growth rate was estimated to be quite low (2.2% in my 1993 paper).   Most important in my view is that the poor economic performance in the developed countries in the past few years is due to economic policy in general (which can change) not to some exogenously imposed “new neutral.” Also, when you ask monetary policy analysts in emerging market central banks around the world, they do not see evidence for such low equilibrium rates. For example, I learned in Colombia the real policy rate has averaged about 2 percent since inflation targeting began. My informal poll of emerging market central bankers at Jackson Hole revealed the same: two to three percent.

Of course, this debate centers on the real policy rate in the long run.  There is more room for disagreement about the short run or the medium run, but for now the terminal rate of 4% still seems about right to me.

Posted in Monetary Policy

The American Economy: Turtle or Caged Eagle?

Last week I was on a panel with Stanford President John Hennessy and Congressman Paul Ryan at the new Hoover Institution Offices in Washington. Al Hunt moderated the discussion which focused on policies to raise economic growth. The video is here.

The discussion revealed both a sense of urgency and of optimism.  I am convinced that we sorely need a major change in US economic policy to address the problem of low economic growth, only 2 percent since the end of the recession 5 years ago compared to years of 4 or 5 percent growth following earlier deep recessions in the US. That’s huge. It means that we have far fewer resources available for both private and public use.

I argued, as I have been arguing for a long time, that the cause of weak growth is poor economic policy. But Al Hunt asked me if it was all over for a strong growth in America. After all, more and more people are talking of secular stagnation and telling stories that we have picked all the low hanging fruit. I just don’t see that, maybe because I come from Silicon Valley where you see invention and innovation all over the place. But neither does John Hennessy, who knows as much as anyone about information and technology (also from Silicon Valley), or Paul Ryan, who knows as much as anyone about policy. You get a sense of the optimism from watching them on the video.

The cover of The Economist last week portrayed the US economy as a turtle crawling along as its rider tragically tries to get it to move faster, but it is clearly incapable. This may be the way that the secular stagnationists or high-hanging fruiters see it.

Economist turtle

To me a much better picture for the US economy is a a sleeping giant ready to be awakened or better yet, a caged eagle. If you removed the cage of poor policy. then the economy would soar again.

caged eagle

Posted in Slow Recovery, Teaching Economics

The Ayes Have It, While Greenspan and Many Others Comment.

This week the House Financial Service Committee voted to approve legislation requiring the Fed to report a policy rule or strategy for setting the instruments of monetary policy.  The legislation now goes to the full House, with a vote likely sometime in September. Technically the Committee vote was on a “Motion to Report Favorably H.R. 5018, The Federal Reserve Accountability and Transparency Act of 2014, as amended.” The requirement for policy rules is Section 2, the first main section of that bill. (For a civics lesson, you can watch the clerk of the Committee count the Ayes and Nays on this video starting at 45:55 and ending with “Mr. Chairman the ayes were 32 and the nays were 26”)

Since this bill was first introduced on July 7 there have been hearings and a lot of interesting commentary in op-eds, TV interviews, blogs and social media as I summarized in previous posts here and here.

More commentary came this past week including importantly from former Fed Chair Alan Greenspan who said this on Bloomberg TV ar 17:58

“What I found very interesting is that this new legislation, which of course is to match the Taylor rule, came out recently. When the Taylor was originally [proposed, Taylor put] in his econometric analysis of what the Fed was doing from 1987 to 1993. So I think that if we could replicate that in some form or another that’s the way we should be functioning.  The problem however is going from where we are now, which is a very bloated set of balances sheets, which require an unprecedented procedure.  We are not yet back to the point where we have a normalized monetary policy. And I think that‘s a critical question that’s going to be an experiment issue. It’s going to be very tough.”

Of course the legislation does not require the Fed to follow the Taylor rule—that rule simply serves as a reference rule. But Greenspan reminds us that during periods when the economy was doing well, policy was close to the recommendations of such a rule, and as a matter of logic monetary policy should try to replicate that.

Other commentary worth studying includes Martin Feldstein’s Fighting the Fed on Project Syndicate,  Peter Ireland’s A Useful Rule for Monetary Policy on Ec21, David Papell’s How Janet Yellen Might Have Responded to the Policy Rules Legislation on Econbrowser, and Simon Johnson’s The Fed in Denial on Project Syndicate.

Feldstein says that the legislation “still leaves the Fed substantial discretion” while Ireland and Papell show, in different and complementary ways, how the Fed could conduct policy if the new legislation was in place. Simon Johnson is more skeptical and criticizes the Fed on other grounds.

Feldstein also delves into the history of thought when he writes that the Taylor rule was “based on his statistical estimate of what the Fed appeared to have been doing under Paul Volcker and Alan Greenspan during a period of both low inflation and low unemployment.” But my paper had no statistical estimates. The design of that rule, including the choice of right-hand-side variables and the left-hand-side interest rate instrument, was based on research with new monetary models that I was developing at the time, especially simulations of alternative rules in such models.  I compared the proposal with decisions during the early Greenspan period (but not the Volcker period) to show that the proposal was practical, as I wrote in a blog several years ago.

Posted in Monetary Policy

Discussion of Policy Rule Legislation Continues

Discussion and debate about new policy rule legislation continued during the past week.  I replied to Alan Blinder’s  article, “An Unnecessary Fix for the Fed,” published in the Wall Street Journal last Friday (July 18).  I show that Alan’s article was actually criticizing a straw man of his own making, not the proposed law itself. His main argument is that the legislation “seeks to intrude on the Fed’s ability to conduct an independent monetary policy, free of political interference.”  I anticipated and refuted this argument in an article, “How to Spark Another ‘Great Moderation,’” published in Wall Street Journal on July 16. As I stated there, the legislation is very clear that “the Fed, not Congress, would choose the rule and how to describe it” and “since the Fed chooses its own rule, its independence is maintained.” My response goes into more detail.

Another example where the commentary does not address the actual bill is a blog at The Economist which states that “The legislation would require the Federal Reserve to set interest rates according to a Taylor rule.”  That’s incorrect. There is nothing in the bill that says that.  Again the Fed would choose its own rule or strategy and also choose how to describe it to the Congress and the American people.  I also note that back in 2007 The Economist was one of the first publications to use the Taylor rule to point out the problems with deviating from rules-based policy leading up to the financial crisis. The new writers have now adopted a different view.

The Economist blog post also refers to an opinion poll of a group of economists who disagree with provisions in the new bill.  I would note that this is the same opinion poll of economists who argued that the stimulus package worked, a issue about which other economists disagree. As with the effectiveness of the stimulus  there are plenty of economists who disagree with the economists in that poll on the new bill.

There is a clear precedent for the type of congressional oversight in the new bill. During another period of poor economic performance in the late 1970s the Federal Reserve Act was amended to require that the Fed report the ranges for the future growth of the money supply, but these requirements were removed from the law in 2000. The requirements did not reduce the Fed’s independence, though initially the Fed vigorously protested the proposed legislation.  In fact many judge that the 1980s and 1990s were a time when the Fed regained its de facto independence. That could well happen again if the new bill were passed into law.

Posted in Monetary Policy

What a Rollout!

Last week (July 7) I wrote on this blog about a newly-introduced bill  that would require policy rules for the Fed. Since then a Congressional hearing was held on the bill on July 10, Fed Chair Janet Yellen was cross-examined about it in two more Congressional hearings on July 15 and 16, and the proposal has been widely-covered in the press, social media, blogs, and opeds. And all this occurred just 6 weeks following the Centennial conference we had out here on policy rules for the Fed. What a rollout!

Here is the first main section (Section 2) of the legislation, HR 5018, which has attracted so much coverage.  Section 2 is only 10 pages, and much of that is a list of definitions.  So you do not have to wait until it is passed to read it.

Here is some of the reporting on the July 10 hearing: House Republicans Restart Their War on the Fed,   Republicans  Want Fed  to Report to Congress on Monetary Policy,   House GOP Bill Turns to Bush Economist to Rein in Fed,   Congress Eyes Rules for the Fed. Here is my written testimony at that hearing and the complete video of the hearing.

Here is the New York Times and Wall Street Journal news reports on yesterday’s hearing.

Here is an informative blog post submitted by David Papell and his colleagues on Econbrowser explaining why the bill’s authors chose the Taylor Rule to be the Reference Rule

Here is my Wall Street Journal article from yesterday.

There is much more that you can uncover with search engines, but overall I think the debate has been informative, including that during the semi-annual hearings with Janet Yellen and subsequent press reporting . As I read the legislation, I have to say that I completely disagree with Janet Yellen that it would be “grave mistake” for Congress to pass it or that it “would essentially undermine central bank independence.”  I have to agree with the Members of Congress who characterized this as an alarmist response as reported in the New York Times by Binyamin Applebaum.

Posted in Monetary Policy