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

The Taylor Curve Has Two Dimensions In Both Hemispheres

Springtime in the Southern Hemisphere is wonderful, and I have been having fun here for the past 10 days, keynoting at two great conferences, with one talk on central bank independence at the Central Bank of Chile and another talk on inflation targeting at the South African Reserve Bank.

Olivier Blanchard joined me in the keynote in Chile, which brought out differences between us that were obvious to everyone (for example, he made the case for capital controls or at least “capital flow management”). In contrast, the differences between me and Lars Svensson, who joined me in South Africa, were small. We both argued that monetary policy should not deviate from inflation and output stability goals for so-called macro-prudential reasons.

I had more disagreements with the paper John Williams presented in South Africa. He started off with an incidental, but misleading or at least incomplete reference to Milton Friedman.  John said “To paraphrase Milton Friedman ‘we are all inflation targeters now’” informing the audience that Friedman once admitted that “we are all Keynesians now.” What Milton actually said was “In one sense, we are all Keynesians now; in another, nobody is any longer a Keynesian,” as he explained in his autobiography with Rose (p. 231) adding that  “The second half is at least as important as the first—the first sense had to do with rhetoric, the second with substance.”

But more seriously, the evaluation of inflation-targeting as a strategy for monetary policy in John’s paper—the main purpose of the paper—was also misleading or at least incomplete. Rather than consider the performance of both inflation stability and output stability—as virtually all monetary policy evaluation studies have done for the past 40 years—he looked only at the first—inflation stability. To paraphrase Milton “the second is at least as important as the first.” Yes we know that inflation has been low and steady in recent years. The problem is that output or employment performance has been terrible—in the US we have had the Great Recession and the Not-So-Great Recovery. That deterioration should be part of the evaluation too.

A number of years ago I developed a framework—the so-called Taylor Curve—to do such a two-sided evaluation, and it has been used many times since then by central bankers. Here is a version that Ben Bernanke used ten years ago, which I have updated. It shows improved macro performance from A to B and then deterioration of performance from B to C.  In evaluating monetary policy one cannot simply hide the vertical axis of the Taylor curve, as the paper by John Williams effectively did

Taylor Curve - Bernanke

Posted in Monetary Policy

Wanted: A New Handbook of Macroeconomics

The first volume of the Handbook of Macroeconomics, edited by Michael Woodford and me, was published in 1999 in the midst of the Great Moderation.  It still ranks first in total downloads of all economics books according to Research Papers in Economics (RePEc). This is perhaps not so surprising given all distinguished contributors to the volume like Hansen, Solow, Shiller, Bernanke, Mankiw, Hall, Browning, Gertler, Christiano, Eichenbaum, Evans, Stock, Watson, Bordo, Schwartz, Durlauf, Quah, Benhabib, Farmer,  Evans, Honkapohja, Heckman, McGrattan, Caballero, King, Rebelo, Ramey, West, Mortensen, Pissarides, Persson, Tabellini, Chari, Kehoe, Calvo, Vegh, Elmendorf, Schmitz, McCallum, Gilchrist, Campbell, and Attanasio

But much has changed in macroeconomics in the past 15 years—including the sad end of the Great Moderation, the financial crisis, the Great Recession, the Not-So-Great Recovery, and a substantial rethinking of macro models and macro policy.  So a new Handbook is sorely needed, and Harald Uhlig and I have agreed to put one together with Elsevier as the publisher again.

A key part of the creation of such a Handbook is a conference where contributors can present and discuss their ideas. Because there will be many contributors, Harald and I have arranged for two conferences, one hosted by the Hoover Institution at Stanford University on April 9-11, 2015, and the other hosted by the Becker-Friedman Institute at the University of Chicago on April 23-25, 2015. These conferences promise to be fascinating.  They will bring together a wide range of distinguished macroeconomic researchers to exchange views about the current state of macro. The Handbook will then follow.

The following Table of Contents for the Handbook shows the economists who will contribute and will appear either at the Hoover conference or the Becker-Friedman conference. The volume is divided into parts which distinguish between empirical, theoretical, methodological, and policy issues.  I am really looking forward to these back-to-back conferences next spring.

Handbook of Macroeconomics Volume 2  John B. Taylor,  Harald Uhlig (Editors)

The Facts of Economic Growth and Economic Fluctuations

  1. Business Cycles                                                                        Ed Prescott
  2. The Facts of Economic Growth                                                Chad Jones
  3. Macroeconomic Shocks and Their Propagation                   Valerie Ramey
  4. Macroeconomic Regimes and Regime Shifts                       Jim Hamilton
  5. The Macroeconomics of Time Allocation                            Mark Aguiar and Erik Hurst
  6. Household and Firm Credit Flows                                      Amir Sufi and Atif Mian
  7. Prices and Wages                                                                      Susanto Basu, Chris House
  8. Financial and Fiscal Crises                                                    Mike Bordo and Chris Meissner

The Methodology of Macroeconomics

  1. Factor Models for Macroeconomics                                     James Stock and Mark Watson
  2. Solution and Estimation Methods for DSGE Models        Jesus Fernandez Villaverde, Juan Rubio-Ramirez, and Frank Schorfheide
  3. Recursive Contracts and Endogenously Incomplete Markets        Mikhail Golosov and     Aleh Tsyvinski
  4. Macroeconomics and Heterogeneity (including inequality)       Dirk Krueger and             Fabrizio Perri
  5. Natural Experiments in Macroeconomics                        Nicola Fuchs-Schündeln and Tarek Hassan
  6. Self-confirming Equilibria, Robustness and Applications             Tom Sargent
  7. Accounting for Business Cycles with Wedges                         V.V. Chari
  8. Incomplete Information in Macroeconomics                     Marios Angeletos

Financial-Real Connections

  1. Credit and Financial Frictions                                     Mark Gertler and Nobu Kiyotaki
  2. Macroeconomics and Financial Markets             Harald Uhlig and Veronica Guerrieri
  3. Macro,Money and Finance:A Continuous Time Framework    Markus Brunnermeier and Yuliy Sannikov
  4. Housing and Macroeconomics                          Monika Piazzesi and Martin Schneider
  5. Term Structure of Uncertainty in the Macroeconomy      Jaroslav Borovicka and Lars Hansen
  6. International Debt Crises   Hal Cole, Satyajit Chatterjee, Mark Aguiar, Zach Stangebye

Models of Economic Growth and Fluctuations

  1. Long-run Growth                                                          Oded Galor
  2. Family Macroeconomics          Matthias Doepke and Michele Tertilt
  3. Environmental Macroeconomics     John Hassler, Per Krusell, and Tony Smith
  4. Models with Price and Wage Rigidities                         John Taylor
  5. Neoclassical Theories                                                     Lee Ohanian and Gary Hansen
  6. Labor Markets and Unemployment                         Robert Shimer
  7. Uncertainty and Macro                                              Nick Bloom and Steven Davis
  8. Macroeconomics of Persistent Slumps                       Bob Hall
  9. Macroeconomics and the Labor Market                  Larry Christiano, Marty Eichenbaum, and Mathias Trabandt                                

Macroeconomic Policy

  1. Macro Models Used at Central Banks and New Challenges                  Jesper Linde, Frank Smets. and Raf Wouters
  2. Macroprudential Financial Regulation                       Anil Kashyap
  3. Fiscal Inflation                                                                  Eric Leeper, Campbell Leith
  4. New Dynamic Public Finance                                                   Iván Werning
  5. Deficits, Debt, Fiscal Crises and Fiscal Consolidation                     Enrique Mendoza, Pablo D’Erasmo, Jing Zang
  6. Political Economy and Macroeconomics                                                Alberto Alesina
Posted in Teaching Economics

Across the Great Divide: New Perspectives on the Financial Crisis

A year ago today, the Hoover Institution and the Brookings Institution held an unusual joint conference on the financial crisis, where twenty-four economists and legal scholars reexamined the crisis, its effect on the US economy, and possible policy reforms. The participants were spread between two venues: Hoover at Stanford and Brookings in Washington.  The conference was simulcast so that people at each location could see and hear people at the other location.

This month a book titled Across the Great Divide, containing all the conference papers and edited by Martin Baily and me will be released.

Cover - Across Great Divide

We chose that title because it is symbolic of the wide range of different opinions represented at the conference.  As we wrote in the introduction, “while both Brookings and Hoover are proud of the range of scholars within each institution that embrace different politics and economic philosophies, Brookings is often seen as center left while Hoover is center right, so it was an important step to undertake this joint conference as a way of expanding the dialog…”

Indeed there were differences of opinion. The conference included the first presentation by Larry Summers of his secular stagnation idea which has since become a widely cited reference as a possible explanation for the slow growing economy of recent years. But it also included alternative views, such as mine, that the slow growth has been due to poor economic policy and can be ended with a change in policy.  The conference included both those critical of the Fed and those who praised the Fed in recent years.

Despite these differences, there was, as George Shultz emphasized in his concluding remarks, “more agreement here than people may have expected,” suggesting therefore that perhaps the conference helped to narrow “Great Divide.”  He noted, for example,  that people at the conference “all instinctively do realize” that bailouts change people’s behavior in an undesirable way and that we need to look for ways that encourage people in leadership positions to resist bailouts. As he put it: “for all of the fascinating and important issues…in this conference to work, there have to be some people at the top with guts who are willing to look at these things and see them through. It isn’t easy.”

Here is the table of contents for the book:

Introduction Martin Neil Baily and John B. Taylor

Chapter 1 How Efforts to Avoid Past Mistakes Created New Ones: Some Lessons from the Causes and Consequences of the Recent Financial Crisis Sheila C. Bair and Ricardo R. Delfin

Chapter 2 Low Equilibrium, Real Rates, Financial Crisis, and Secular Stagnation Lawrence H. Summers

Chapter 3 Causes of the Financial Crisis and the Slow Recovery: A Ten-Year Perspective John B. Taylor

Chapter 4 Rethinking Macro: Reassessing Micro-foundations Kevin M. Warsh

Chapter 5 The Federal Reserve Policy, Before, During, and After the Fall Alan S. Blinder

Chapter 6 The Federal Reserve’s Role: Actions Before, During, and After the 2008 Panic in the Historical Context of the Great Contraction Michael D. Bordo

Chapter 7 Mistakes Made and Lesson (Being) Learned: Implications for the Fed’s Mandate Peter R. Fisher

Chapter 8 A Slow Recovery with Low Inflation Allan H. Meltzer

Chapter 9 How Is the System Safer? What More Is Needed? Martin Neil Baily and Douglas J. Elliott

Chapter 10 Toward a Run-free Financial System John H. Cochrane

Chapter 11 Financial Market Infrastructure: Too Important to Fail Darrell Duffie

Chapter 12 “Too Big to Fail” from an Economic Perspective Steve Strongin

Chapter 13 Framing the TBTF Problem: The Path to a Solution Randall D. Guynn

Chapter 14 Designing a Better Bankruptcy Resolution Kenneth E. Scott

Chapter 15 Single Point of Entry and the Bankruptcy Alternative David A. Skeel Jr.

Chapter 16 We Need Chapter 14—And We Need Title II Michael S. Helfer

Remarks on Key Issues Facing Financial Institutions Paul Saltzman

Concluding Remarks George P. Shultz

Summary of the Commentary Simon Hilpert

Posted in Financial Crisis, Slow Recovery

Inequality Conference in Memory of Gary Becker at Stanford’s Hoover Institution

Last Thursday and Friday the Hoover Institution at Stanford hosted a wonderful Conference on Inequality in Memory of Gary Becker. John Raisian and I opened the conference commenting on the appropriateness of both the venue and the topic: Gary spent a great deal of time doing research at Hoover over the years, and he began diagnosing and recommending policy solutions to inequality problems decades ago, long before the current explosion of popular interest.

I recalled his policy advice on the issue two decades ago in a presidential campaign memo: “we have seen income distribution widen in the United States and other countries” and that reflects, he said, “a particular problem with the education and training of those at the lower end of the income distribution.” He advised that “the aim of policy reforms in this field should be to help stimulate economic growth by encouraging better quality and more effective schooling and training, especially for those at the bottom and middle of the human capital distribution.” This “will both raise economic growth and also reduce inequality in earnings.”

Gary took economics very seriously, including when he applied it to policy. For Gary, economics and economic policy were inseparable, and a goal of the conference was to bring out that inseparability. Here is a quick summary. A book on the conference will appear soon, and more information can be obtained from the individual speakers.

The conference began with an overview of the facts placed in context by Jim Pierson who made use of his provocative new book The Inequality Hoax and an informative chart book prepared for the conference by Tom Church.  Jim reviewed the data collected by Piketty and Saez and put these in the context of the recent policy debate in the US.

We then shifted to Casey Mulligan whose presentation, “The Effects of Redistribution Policies on Growth and Employment,” showed that attempts to reduce inequality through a host of new government re-distribution policies had the unintended consequence, at least during recent years, of lowering economic and job growth. At the end of his presentation Casey conjectured (in jest?) that the reason a survey of economists at the Chicago Booth School found that these “stimulus policies worked” was that no one on the survey took Gary’s price theory course either at Chicago or Columbia.

Josh Rauh’s session was called, “The Broad-Based Rise in the Return to Top Talent.”  Josh compared two opposing views of the recent increase in income inequality: the economic growth incentive view, in which lower marginal tax rates increase incentives and economic growth, versus the rent-seeking view, in which lower tax rates, for example, reduce the resistance of corporate boards to very high executive pay.  He presented reams of data and examples more consistent with the first view, which of course has bearing on the question of what to do.

Chad Jones, in the session “The Economic Determinants of Top Income Inequality,” presented a nice workable model—thus in the Becker tradition—that enabled him to determine the factors that affect the income distribution over time and across countries. A special feature of his model was a two parameter combination determining the pace of technical change and the dampening of  creative destruction.  He used the models to explain why income distribution did not widen as much in France as in the United States in recent years.

At the end of the first day of the conference, Eddie Lazear and George Shultz reminisced eloquently about their long association with Gary over the years both at Chicago and at Stanford. There is no way that I can do justice to their touching tributes, so you will have to wait for the conference volume.

The second day of the conference began with the session “Inter-generational Mobility and Income Inequality: Facts, Explanations, and Policy Implications.”  One of Gary’s former students, Jörg Spenkuch, presented a paper that he was working on with Gary when Gary died.  It was one of Gary’s last presentations at the Hoover Working Group on Economic Policy, and I remember that well.  It traced out the connection between the income distribution and inter-generational mobility.  A key issue in the model was the connection between parents’ human capital and the ability or effort with which parents are able to pass on that human capital to children.

The next session was a fascinating “debate” on “Income and Wealth Inequality in America and Policies to Address It” with Kevin Murphy and Emmanuel Saez. While they covered many issues, the main take-away was that Kevin Murphy focused on poor education (insufficient supply response) as the source of the inequality problem and recommended improvements in education, while Emmanuel Saez focused more on higher tax rates as the way to reduce inequality.

In keeping with the policy theme, the conference concluded with a Panel on Solutions, with John Cochrane, Lee Ohanian, and George Shultz focusing mainly on what policies would most help those below the 1%. John focused on the fundamental question of why so many in academia, the media, and policy circles seem to care so much about the 1%.  (A survey reported by Dan Kessler at the conference found that most other people do not care so much). John argued that such an emphasis gets in the way of implementing policies which actually help those with lower incomes. Lee Ohanian focused on education (with many graphic stories and statistics—including examples of what is actually on those achievement tests) and immigration reform. Shultz proposed a more hard-nosed, roll-up-your-sleeves approach with practical solutions including health and micro-finance programs like those promoted by Muhammad Yunnis. No one on this panel called for higher tax rates as a solution.

A stated purpose of the conference—starting from the early planning stages—was to address “the key policy question of what to do, with particular attention to those at the bottom of the income distribution and the overall effects on economic growth.” As evidenced by this last panel and indeed most of the other presentations and discussions at the conference, this was exactly how the conference turned out.


Posted in Teaching Economics


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 Boris 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