Application Deadline Approaching for Free Public Policy Program

After a very successful launch last summer, Stanford’s Hoover Institution is again offering a one-week public policy boot camp this coming August 19-25. This “residential immersion program” is aimed at college students and recent graduates. It consists of lectures, workshops, informal discussions, and active collaboration with study groups outside of class.  It covers the essentials of today’s national and international policy issues. It requires a 100% time commitment for the whole one-week program, but if last year is any indicator both faculty and students will find it to be rewarding and fun.

As with last year the teachers in the program are faculty and fellows from the Hoover Institution, which includes scholars in economics, government, political science, and related fields. This summer the lineup includes economists Terry Anderson, Michael Boskin, John Cogan, Caroline Hoxby, Edward Lazear, Joshua Rauh, George Shultz, Amit Seru, and me, along with political science and national security experts Scott Atlas, David Brady, James Ellis, Stephen Haber, Daniel Heil, Michael McConnell, Kori Schake, Kiron Skinner, and Bill Whalen. Last year I talked about monetary policy and the Fed, and I will do the same this year, updated of course.

Believe it or not, the program is free of charge to accepted participants, including lodging and meals.  Attendees will be responsible for travel costs and incidentals. There is still time to apply but the application deadlines are fast approaching: February 1, 2018 for early bird applicants and March 1, 2018 for all applicants.   So apply now and I hope we’ll see you next summer!

Posted in Teaching Economics

Unique Cooperative Research Effort

This week marks the 20-year anniversary of a “notable conference” on monetary policy as Ed Nelson, who reminded me, puts it.  The conference took place at the Cheeca Lodge in the Florida Keys on January 15-17, 1998, and it resulted in the book  Monetary Policy Rules published by the University of Chicago Press for the NBER.

It was an unusual conference.  As stated on the back of the book jacket shown below, it was a “unique cooperative research effort between nearly thirty monetary experts and policymakers.” The purpose was to evaluate alternative monetary policies, all of which were described by policy rules for the interest rate. It was unique because the participants in the conference not only evaluated the performance of their own proposed policy rules with their own models, they also evaluated the performance of other participants’ proposed rules with their models. This put the focus on robustness and effectiveness in a way that had not been done before.

As I summarized in the Introduction “we asked researchers who participated in the conference to investigate the other researchers’ proposals for policy rules using their own models. We did not specify what model (whether large or small, rational or nonrational) should be used.  That decision was left up to the researchers.” It turned out that nine models participated in the evaluation exercise, each of which was described in the individual research papers given at the conference:  Performance of Operational Policy Rules in an Estimated Semiclassical Structural Model by Bennett McCallum and Edward Nelson; Interest Rate Rules in an Estimated Sticky Price Model  by Julio Rotemberg and Michael Woodford; Policy Rules for Open Economies by Laurence Ball; Forward-Looking Rules for Monetary Policy by Nicoletta Batini and Andrew Haldane; Policy Rules for Inflation Targeting by Glenn Rudebusch and Lars Svensson; and four models in the Robustness of Simple Monetary Policy Rules under Model Uncertainty by Andrew Levin, Volker Wieland, and John Williams

The main finding of this effort surprised people at the time. It was that “simple policy rules are more robust and more efficient than complex rules with multiple variables,” a finding that has stood the test of time and many more studies of over the past two decades.

It was a tough to establish uniformity in the evaluation method so that each rule was treated fairly. Thanks to the model data base of Volker Wieland and improvements in computer and information technology, it is much easier to do conduct this kind of robustness study now.

Monika Piazzesi, a Stanford graduate student at the time, prepared a very useful summary of the discussion that took place at the conference. Soon afterwards the Fed began referring to the Taylor (1999) rule which had a higher coefficient on output than the so-called Taylor rule.  (1999 was the year the book was published.). I complained because I had not proposed such a rule in the chapter in the book but simply compared it with other rules. Because of my complaint, Janet Yellen started calling that rule the balanced rule from then on, not that the name made much difference.



Posted in Monetary Policy

The Fed’s Inflation Target and Policy Rules

The Brookings Institution held an interesting conference yesterday organized by David Wessel on “Should the Fed Stick with the 2 Percent Inflation Target or Rethink It?” Olivier Blanchard and Larry Summers argued, as they have elsewhere, that the Fed should increase its inflation target—say from 2% to 4%. Others—such as John Williams—argued that the Fed should change the target in some other way such as by focusing on the price level. Sarah Binder, Peter Hooper and Kristen Forbes were on a panel to answer questions about political, market, and international issues, respectively. I was on that panel to answer questions  about monetary policy rules, and the first question posed by David Wessel was about the inflation target in the Taylor rule. Here’s a summary of my answer and later remarks during the course of the panel:

For the policy rule that came to be called the Taylor rule, first presented in 1992, I used a 2% inflation target (π*). This was long before the official adoption of a 2% target by the Fed, the BOJ or the ECB.  The central banks of New Zealand, Chile and Canada were moving toward inflation targeting about that time, but not with the single number of 2% as a target. John Murray presented the Canadian history at the conference.

I chose 2% rather than zero back then because of the upward bias in measuring inflation, which was widely discussed at that time, and because of the zero bound problem for the interest rate.  It was not an arbitrary choice. I also chose an equilibrium real interest rate (r*) of 2%. That was not arbitrary either with the real GDP growth rate trending a little over 2%. The actual rule for the interest rate (i) was i=π+.5y+.5(π-π*)+r* with π*=2 and r*=2. This meant that the equilibrium nominal rate was 4%. In equilibrium the output gap (y) equal zero and the inflation rate (π) equals π*.

Regardless of whether or not the Fed changes its inflation target π* going forward, it is important that its monetary framework be based on policy rules. The good economic performance during the Great Moderation was due largely to policy becoming more consistent with a rules-based framework, and the devastation of the Great Recession was due in part to deviating from rules-based policy.

It is also important for the new research on π* to be based on policy rules. In fact, virtually all economic research on the matter has been conducted using policy rules, including the important recent work by Fed economists Michael Kiley and John Roberts for the Brookings Papers on Economic Activity—a paper which was widely cited at the conference.  The whole new section on policy rules in the Fed’s recent Monetary Policy Report and speeches last year by Fed Chair Janet Yellen also use this approach.

All the alternative proposals considered at this conference can and should be evaluated using policy rules, including price level targeting, nominal GDP targeting, and different inflation targets. If you want to evaluate a higher inflation target, you just stick in a higher value for π*.  If you choose an inflation target of 4% with r* still 2%, then the average nominal rate will be 6%. If r* was 0% rather than 2%, an inflation target of 4% would mean an equilibrium nominal interest rate of 4%, exactly as in the original Taylor rule. In each case one can evaluate performance of the economy over a range of models as in Volker Wieland’s model data base.

Such policy rules or strategies would fit into the legislative language in recent bills in Congress, including the “Monetary Policy Transparency and Accountability Act,” which simply require the Fed to describe its policy strategy and compare it with policy rules of its own choosing. The rules would also help clarify the Fed’s actions to the markets and to policy makers in other countries.

The main motivation for the newer inflation targeting proposals is concern about the zero lower bound (ZLB), or the effective lower bound, on the interest rate.  But the lower bound is not a new thing in economic research. Policy rule research took that into account long ago. In my 1993 book, for example, I noted that the policy rule “must be truncated below some nonnegative value.” We used 1% then: whenever the policy rule “calls for a nominal interest rate below 1 percent, the nominal interest rate is set to 1 percent.”

Another alternative is to move to a money growth regime. For example, in 1996 I noted that the interest rate rule needed “to be supplemented by money supply rules in cases of either extended deflation or hyperinflation.” Recently, Peter Ireland and Michael T. Belongia have suggested a return to money growth rules in the case of the ZLB.

Other proposals for dealing with the zero bound have been made over the years. In 1999 David Reifschneider and John Williams proposed that the interest rate be kept extra low following an ZLB period. For example, the interest rate would be kept at zero until the absolute value of the cumulative sum of negative deviations of the actual interest rate from the ZLB equals what occurred during the period of the ZLB.

Many at the conference thought that the ZLB is more of a problem now than in the past because estimates of r* have fallen. But those estimates are uncertain and may reverse soon. Volker Wieland and I demonstrated this uncertainty, especially in current circumstances, in considering the influential research of Thomas Laubach and John Williams. The low estimates of r* may be due to “fog” cause by unusually low policy interest rates and unconventional monetary policies at many central banks. Permanently changing the target inflation rate may not be the best response.

There are also international considerations. As we all know the original 2% inflation target is becoming universal for central banks around the world, and there is also a clamoring for a more rules-based international monetary system. One reason for the clamoring is research showing the increased exchange rate and capital flow volatility of recent years has been due in part to a deviation from a rules-based system. Now is an opportune time to move in the direction of a rules-based international system by simply reporting on the policy strategy in each country. Changing the inflation target in these strategies unilaterally will make this more difficult.

For all these reasons, I would be hesitant to change the inflation target introduced 25 years ago.  But as research on policy rules at the Fed and elsewhere continues, I hope two related concerns are addressed.

First, there is a danger in the way that the numerical inflation target has come to be used in practice. It seems that even if the actual inflation rate is only a bit below the 2% inflation target—say 1.5% or 1.63%—there is a tendency for people to call for the central bank to press the accelerator all the way to the floor. This is not good monetary policy; it is not consistent with any policy rule I know, and it could create excesses or even bubbles in financial markets. This problem could be remedied as the Fed continues to clarify its strategy.

Second, the greater attention to a numerical inflation target may have reduced attention to other aspects of the policy rules, including the idea that we need a policy rule at all. In other words, trying to give more precision to π* may have led to less precision about other parameters, including the sizes of the responses. Recall that the Fed and other central banks moved toward rules-based policy well before they adopted formal numerical inflation targets.  Most of the move to rules-based policy occurred during the period when Paul Volcker and Alan Greenspan simply said that inflation should be low enough that it did not interfere with decision- making. Again, I think this problem can be remedied as the Fed continues to clarify its strategy.

Posted in Monetary Policy

Happy New Decade!

The Great Recession began exactly one decade ago this month, as later determined by the NBER business cycle dating committee chaired by my colleague, Bob Hall. There is still a great debate about the causes of the Great Recession, its deepness, its length, and the Not-So-Great Recovery that followed. But there is no question that the economic growth rate over the past ten years has been dismal—only 1.4 percent per year on average. A chart of the ten-year moving average of growth rates tells the story. Let’s hope the new decade that begins tomorrow will be a happier new decade for economic growth in the United States.

I still think the explanation in my 2009 and 2012 books Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis and First Principles: Five Keys to Restoring Americas Prosperity are basically correct, and I am encouraged that there has been a turnaround recently in regulatory policy and tax policy.

But more investigative research into real-time records of policy actions is essential to determine what went wrong during the past decade.  A good example is the new book, forthcoming in 2018, The Fed and Lehman Brothers: Setting the Record Straight on a Financial Disaster, by Larry Ball which investigates the records and uncovers inconsistencies in the government’s story of its role in the panic of 2008. He shows that the Fed could have legally prevented the chaos surrounding the Lehman bankruptcy, but didn’t do so either because of political concerns or a botched implementation of its game plan.

It is also essential to review and assimilate all the policy research that has been done in the past decade, both inside and outside of government institutions. In this regard, also ten years ago this month we created an Economic Policy Working Group at the Hoover Institution with the express purpose of doing policy-related research on the crisis, focusing on the change in policy that many of us—including George Shultz, John Cogan, Darrell Duffie, Michael Boskin, Ken Scott—saw had begun a few years before. The group has grown and now includes many more economists, including John Cochrane and Josh Rauh who moved from the University of Chicago. The 160 policy meetings and conferences organized by this Working Group have been the source of many papers and books including the early research work on stimulus packages, quantitative easing, bankruptcy reform, international monetary reform, and, most recently, John Cogan’s The High Cost of Good Intentions.  To aid in communication and assimilation, brief summaries of all the meetings were written and collected in real time and are available here on the Hoover website here. Some of the recent summaries by John Cochrane are very thoughtful essays on their own right.

Posted in Financial Crisis, Slow Recovery, Teaching Economics

What’s Past is Prologue. Study the Past


Each year the Wall Street Journal asks friends for their favorite books of the year. Two years ago I chose Thomas Sowell’s history of income distribution in Wealth, Poverty, and Politics and Brian Kilmeade’s history on Thomas Jefferson and the Tripoli PiratesLast year I chose The Man Who Knew, Sebastian Mallaby’s biography of Alan Greenspan, and War by Other Means by Bob Blackwill and Jennifer Harris.

This year I chose two amazingly relevant  books on U.S. economic history: John Cogan’s The High Cost of Good Intentions: A History of U.S. Federal Entitlement Programs and Doug Irwin’s Clashing over Commerce: A History of US Trade Policy. My reasons in brief are found in the passage below from the printed December 16 WSJ edition. In these days of big economic policy changes, history is essential, and if I had room for a third book, it certainly would be another economic history, namely Tom Hazlett’s The Political Spectrum: The Tumultuous Liberation of Wireless Technology, from Herbert Hoover to the Smartphone.


Posted in Budget & Debt, International Economics, Teaching Economics

A Policy Rule Presented at a Conference 25 Years Ago Today

Ed Nelson sent me a nice note today saying that the past two days (November 20-21) mark “the twenty-fifth anniversary of the Carnegie-Rochester Conference at which you laid out your rule.” I had forgotten about the specific dates, but his note reminds me how much has changed in those 25 years.

Back then, research on monetary policy rules was indicating that rules needed to be very complex with many variables and many lags. There were serious doubts about the usefulness of the research, and some expressed doubts that the results would ever be applied in practice. I had been conducting research at Stanford in the 1980s with a number of graduate students including Volker Wieland and John Williams. So Allan Meltzer (who organized the Conference Series with Karl Brunner) called me and requested that I present a paper on the subject at the November 1992 conference.

The question was: Could we design a simple practical policy rule that was consistent with our research? The answer turned out to be yes, with the interest rate—the federal funds rate—rather than the money supply or the monetary base as the instrument.  The Fed still wasn’t talking publicly about its settings for the federal funds rate, so there was criticism of that design. However, several discussions with Alan Greenspan, who was then Chair of the Fed, gave me a degree of confidence that this approach was workable. In fact, Greenspan later joked that the Fed deserved an “assist” in the developing the Taylor rule.

Ben McCallum was the discussant of my paper at the conference, and he recently wrote a retrospective on the impact of the conference and the rule.  Ben describes how the request to me from Allan Meltzer originated in a meeting of the Carnegie-Rochester Advisory Board on which Ben served.  Ben’s recollection of what Allan was supposed to ask me to do was quite different from what I recall Allan actually asked me to do.  We will perhaps never know how that interesting “miscommunication” arose, but it clearly made a difference.

Posted in Monetary Policy, Teaching Economics

New Results on International Monetary Policy Presented at the Swiss National Bank

This week I gave the Swiss National Bank’s  Annual Karl Brunner Lecture in Zurich, and I thank Thomas Jordan who introduced me and the hundreds of central bankers, bankers, and academics who filled the big auditorium. Karl was a brilliant, innovative economist who thought seriously about both policy ideas and institutions. For the lecture, I focused on ideas and institutions for international monetary policy.

Since Karl died in 1989, we can only wonder what he would think about monetary policy in the past dozen years. But we can get some hints from his former student, collaborator, friend, and great economist Allan Meltzer, who died earlier this year.

About one year ago at the annual monetary conference in Jackson Hole, Meltzer argued that the Fed’s “quantitative easing” was in effect a monetary policy of “competitive devaluation,” and he added that “other countries have now followed and been even less circumspect about the fact that they were engaging in competitive devaluation. Competitive devaluation was tried in the 1930s, and unsuccessfully, and the result was that around that time major countries agreed they would not engage in competitive devaluation ever again.”

In the lecture, I examined this idea empirically, and I found striking results. A monograph with the details will soon be published by the MIT Press, but a very short taste of the results can be given here.

I began by introducing a simple modelling framework which captures key features of recent economic policy. I focused on the balance sheet operations of the Federal Reserve, the European Central Bank, and the Bank of Japan. I concentrated on the liability side and, in particular, on reserve balances which are used to finance asset purchases, as a measure of the balance sheet operations. For the three central banks this gives RU which measures the Fed’s reserve balances in millions of dollars, RJ which measures the BOJ’s current account balances in 100s of million yen, and RE  which measures the ECB’s current account plus deposit facility in millions of euros. I also considered the central bank in a relatively small open economy—the Swiss National Bank.

To examine the impact of the balance sheet operations of the central banks in the three large areas I estimated the following equations.

XJU = α0 + α1RJ + α2RU + α3RE

XJE = β0 + β1RJ + β2RU + β3RE

XUE = γ0 + γ1RJ + γ2RU + γ3RE

where XJU is the yen per dollar exchange rate; XJE is the yen per euro exchange rate; and XUE is the dollar per euro  exchange rate.

All the estimated coefficients are significant, and they showed that:

  • An increase in reserve balances RJ at the Bank of Japan causes XJU and XJE to rise, or, in other words, causes the yen to depreciate against the dollar and the euro.
  • An increase in reserve balances RU at the Fed causes XJU to fall and XUE to rise, or, in other words, causes the dollar to depreciate against the yen and the euro.
  • An increase in reserve balances RE at the ECB causes XJE and XUE to fall, or, in other words, causes the euro to depreciate against the yen and the dollar.

The charts below show the patterns of reserve balances and the corresponding exchange rate movements: first there is the increase in reserve balances at the Fed with a depreciation of the dollar; second there is an increase in reserve balances at the BOJ with a depreciation of the yen; and third there is increase in reserve balances at the ECB and a depreciation of the euro.

In other words, there are significant exchange rate effects of balance sheet operations for the large advanced countries.  In the lecture I then went on to show that there are similar effects for the Swiss National Bank, as in other central banks in small open economies that have little choice but to react to prevent these unwanted moves in their own exchange rates.

These exchange rate effects are likely to be a factor behind balance sheet actions taken by central banks and the reason for the policy contagion in recent years as countries endeavor to counteract other countries’ actions to influence exchange rates. In this sense, there is a “competitive devaluation” aspect to these actions as argued by Allan Meltzer—whether they are intentional or not.

The resulting movements in exchange rates can be a source of instability in the global economy as they affect the flow of goods and capital and interfere with their efficient allocation. They also are a source of political instability as concerns about currency manipulation are heard from many sides. They are another reason to normalize and reform the international monetary system. In my view a rules-based international system is the way to go, as I discussed in the lecture at the Swiss National Bank referring to earlier work here.


Posted in International Economics, Monetary Policy