Economics One

Here are the ten courses that have been chosen by https://mashable.com/uk/deals/best-free-online-courses-stanford-university as the best Stanford University courses to take online. And Economics 1 at Stanford https://www.edx.org/course/principles-of-economics is on the list. They are all on edX. As they say: “All products featured are independently selected by the editors and writers.”

In a Bloomberg TV interview today, Romaine Bostick @romainebostick and Scarlet Fu @scarletfu asked me great questions about the just-released inflation rate and the implications for Fed policy. During the interview, which goes for about 7 minutes from 3:50 to 11:13, I argued that the Fed was not done, that they needed to raise the Federal Funds interest rate some more, and that they should not give up on their 2% inflation target.

I referred to the book –“HOW MONETARY POLICY GOT BEHIND THE CURVE AND HOW TO GET BACK”–that has the proceedings of a conference we held a year ago, when the funds rate was only 25 basis points. The message of the conference was that the Fed was behind the curve. Well, a year later they have raised the funds rate, and they are much less behind the curve. The question now is “how to get back, and that will be the focus of our next conference.

Here is a video that contains the interview: https://www.bloomberg.com/news/videos/2023-02-15/-bloomberg-markets-the-close-02-14-2023 .

We just reached a big anniversary:  “Economic Policy Working Group Reaches 15-Year Milestone in Providing Rigorous Policy Analysis and Solutions for American Prosperity,” as the Hoover Daily Report headlined in a just-published article. Here is the article https://www.hoover.org/news/economic-policy-working-group-reaches-15-year-milestone. It provides a beautiful summary of the people, seminars, working papers, and, of course, the books. And the “Rigorous Policy Analysis” and the “Solutions for American Prosperity” are key, and we have always emphasized the international benefits to the world. Here is the list of books, starting with the latest:

And we are just getting started: Last Wednesday at the Economic Policy Working Group (EPWG), Peter Henry talked about “The Global Infrastructure Gap: Potential, Perils, and a Framework for Distinction,” and next Wednesday Michael Bordo will speak about “Muddling Through or Tunneling Through: UK Monetary and Fiscal Exceptionalism During the Great Inflation,” and then  on February 15, 2023 Ellen McGrattan will speak about “On the Nature of Entrepreneurship,” and the following Wednesday Erik Hurst will talk about “The Distributional Impact of the Minimum Wage in the Short and Long Run”

The Working Group’s meetings are now on a virtual platform. As the article states: “the level of participation from policy makers and scholars across the nation and the world has grown substantially.” And we will have another big conference on May 12, 2023. It is so important to keep up the work.

This week, on January 4, 2023, John Cochrane, Mickey Levy, Kevin Warsh & I spoke by Zoom at a policy roundtable on the increase in inflation and possible causes at the Hoover Economic Policy Working Group. It was an important follow-up to a meeting we held a year ago on January 5, 2022. Each of us covered similar ground: Cochrane talked about the fiscal side, Levy about inflation measures, Warsh about regime change, and Taylor about the big deviations in policy from standard monetary policy rules. Many of us had written about these issues since the last group session in January 2002. The aim was to give different perspectives on a common theme: that recent high inflation over the past year was brought about by an extra low policy interest rate, the high money growth, or the big balance sheet expansion.

I talked about how the Fed got into this difficult situation, and I hope that brought back memories of the 1970s where the critique was similar, but also different in important ways. All agreed a year ago that the Fed was behind the curve, and the question was when and how rapidly to get back on track. This was also the title of the Hoover Institution book entitled: “How Monetary Policy Got Behind the Curve — and How to Get Back,” published in May 2022, and edited by Michael Bordo, John Cochrane and John Taylor.

During the past year the Fed had indeed tried to get back on track, and it increased the federal funds rate from near zero to a bit over 4 percent. Some–including most of the speakers and participants–said that more was needed. The event again had many commentators and guests–including monetary experts such as Mervyn King, Andrew Levin, Bob Hall, and David Papell, who spoke out on this theme from different perspectives.

The whole Zoom event from January 4, 2023 was video-recorded, and can be found here: https://www.hoover.org/events/policy-seminar-john-cochrane-mickey-levy-kevin-warsh-and-john-taylor along with a list of participants and the slide presentations. It is fascinating to compare the session this year (Jan 2023) with the session last year (Jan 2022) which had the same group of speakers and many of the same participants: https://www.hoover.org/events/roundtable-economic-policy-john-cochrane-mickey-levy-kevin-warsh-and-john-taylor  It is most fascinating in my view because the theme is similar except that Fed has begun to catch up. How will the economy–and indeed the world economy–look in January 2024? That depends on the Fed and other central banks.

Informative NPR interview and discussion with me https://www.npr.org/2022/11/02/1133720724/john-taylors-formula-for-the-fed conducted by Darian Woods and Mary Childs on the Fed’s decision to raise rates and the Taylor Rule. Good questions and good answers with excerpts from Jay Powell and Janet Yellen. Here is the https://www.npr.org/transcripts/1133720724.

A beautiful book, edited by Robert King and Alexander Wolman, https://www.richmondfed.org/-/media/RichmondFedOrg/publications/research/goodfriend/essays_marvin_goodfriend.pdf with original essays in tribute by Alfred Broaddus Jr., Donald Kohn, William Poole, Kartik Athreya and Stephen Williamson, Ben Bernanke, Michael Bordo and Edward Prescott, Douglas Diamond, Michael Dotsey, Andreas Hornstein, and Alexander Wolman, Huberto Ennis and John Weinberg, Vitor Gaspar and Frank Smets, Mark Gertler, Robert Hetzel, Athanasios Orphanides and John Williams, Charles Plosser, Sergio Rebelo and Pierre-Daniel Sarte, Thomas Sargent, Lars Svensson, John Taylor, Mark Watson, Michael Woodford, Robert King and Yang Lu

Federal Reserve Chair Jerome Powell’s testimony at the House and Senate this week again had much to say about monetary policy rules. The focus on policy rules is encouraging, as it is a way to both get back on track and prevent further harmful deviations in the future, as was the focus of our recent May conference at Hoover and Stanford University

Consider for example the exchange at the Senate Committee on Banking. Housing and Urban Affairs between North Carolina Senator Thom Tillis, the acting ranking member, and Chair Powel on Wednesday June 22. 

According to the written record of his remarks, Senator Tillis  https://www.banking.senate.gov/imo/media/doc/Tillis%20Opening%20Statement%206-22-22.pdf said in his opening that: “Regarding the Fed specifically – though I am pleased you have begun taking the drastic action necessary to right the U.S. economy – these actions are long-overdue and monetary policy remains too loose. CPI inflation now stands at 8.6% per year but the Fed funds rate sits at only 1.6%. According to the Fed’s semiannual report, the rate should be over 6% under the Taylor rule. This disparity indicates not only the lengths the Fed has yet to go to normalize monetary policy, but also the fact that the Fed has largely boxed itself into a menu of purely reactive policy measures. Unless the Fed works quickly to move away from their discretion-based monetary policy approach that has remained consistently well-behind the curve, I am concerned the Fed will lose its credibility to effectively manage the national economic situation.”

Then, at 55 minutes into the hearing according to a recorded videotape, Senator Tillis https://www.banking.senate.gov/hearings/watch?hearingid=DFA0BB5D-5056-A066-60E6-2BD668AE1552 said further that “By the Fed’s own analysis of various policy rules, including the Taylor Rule, the revised Taylor rule, the balanced approach rule, and the balanced approach short fall rule, rates should have begun to rise long before they did. According to the Fed’s own analysis of these rules, the fed funds rate should currently be above 6 percent; this is in the Report to Congress. Yet the rate currently stands at 1.6 percent. Likewise, the same rules could—should—have prompted the Fed to begin raising rates Q4 last year Q1 this year. I’m concerned that the Fed has opted out of rules-based to discretionary monetary policy. As the Fed reviews monetary policy strategy, Chair Powell, will you commit to considering an increased weight for rules based strategy for its decision making and if not why.”

Chair Powell answered: “We do use policy rules like the various forms of the Taylor rule in all of the analysis that we do.  If you are thinking about how monetary policy will affect the economy, you have to have some sort of a rule like that. The Fed has never really used them in a prominent way to actually set policy in real time. But that is not to say that they do not shed light. We do consult them on an ongoing basis. The rules all called for a deeply, deeply, negative rates during the pandemic, and we didn’t do that. They did call of course for rates to move up, and rates now really are moving up much closer to where the Taylor rule—various form of the Taylor rule—are.  And I think by the end of the year will be pretty close to where some of the Taylor rule iterations are.  It is something we consider. I think in a couple of years when we look at our framework again, that’s something we could look at.” 

Senator Tillis then responded: “Chair Powell could you just briefly explain the variance between rules-based decision making being at 6 and where we are today. What are the factors coming into play?”

Chair Powell answered: “Taylor rules don’t keep, they don’t take into consideration changes in financial conditions. They just look at the overnight policy rate. As I mentioned earlier, we began signaling, and we are set up now to signal policy changes going forward with the summary of economic projections that we do four times a year. So markets priced that in, and you are getting a lot of policy tightening well in advance of actually raising rates. As you pointed out we are 1.6 percent only on the federal funds rate, but look out the rate curve, all the…very substantial additional rate hikes are already priced in with financial conditions and they have been for several months. So that’s one way of thinking about it. It’s really only at the very short end of the curve where rates are still in negative territory from a real perspective. If you look farther out, real rates are positive right across the curve. That’s really what we are trying to achieve with policy. In a situation like this where we have forty year highs in inflation, and we know we need restrictive policy. And that is where we are headed.”

The press also covered the hearing. In an article called GOP to Powell: Play by the rules Kate Davidson of Politico wrote on June 23 https://www.politico.com/newsletters/morning-money/2022/06/23/gop-to-powell-play-by-the-rules-00041638 and said that

“We expected Republicans to press Federal Reserve Chair Jerome Powell on the need to tighten policy faster at his Senate hearing Wednesday. But we were struck by how they used the occasion to revive an old GOP talking point: the Fed has too much discretion.”

“Sen. Thom Tillis (R-N.C.), who sat in as the ranking Republican at the session, argued that the Fed should be bound by formalized rules in its interest rate decisions, our Victoria Guida wrote. And he pointed to a formula, named after Stanford economist John Taylor, suggesting that the central bank’s main policy rate should be much, much higher than it is.” “The Fed has largely boxed itself into a menu of purely reactive policy measures,” Tillis said. “Unless the Fed works quickly to move away from their discretion-based monetary policy approach that has remained consistently well behind the curve, I am concerned the Fed will lose its credibility to effectively manage the national economic situation.

And in an article Assessing Monetary Policy Through The Taylor Rule by Blu Putnam, Chief Economist, CME Group, said https://www.cmegroup.com/openmarkets/economics/2022/Assessing-Monetary-Policy-Through-The-Taylor-Rule.html : “In policy circles this trade-off is embodied in what is known as the Taylor Rule, which argues that the Fed should raise rates in line with a simple formula for an assumed inflation-jobs trade-off.… Of note, the Taylor Rule today, and for some time in the past, has been suggesting the Fed needs to start removing accommodation, which is what the Fed is now doing.”

And the discussion went global.  Here as an article about the Bank of England entitled Bank of England’s Interest Rate Should be Closer to 10% says Swiss Re written by Gary Howes https://www.poundsterlinglive.com/economics/17147-bank-of-england-s-interest-rate-should-be-closer-to-10-says-swiss-re “The most significant central bank tightening cycle in decades has begun and we expect much more policy tightening to come this year and next,” says Jérôme Haegeli, Swiss Re Group’s Chief Economist. “Approximations of an adequate interest rate policy, proxied by our estimates of the Taylor rule, suggest that almost all major advanced economy central banks are at least 2ppts below interest rate levels that would be warranted given the current economic environment,” says Haegeli. “The Taylor rule is an equation that prescribes the central bank policy rate as a function of inflation and economic slack such as the output gap or the unemployment gap.”

To conclude this post, the above is just a sampling of the commentary, and much of it is promising. Much has already been written over the years about monetary policy rules, which answers some of the points raised by Jay Powell. These issues will be covered and analyzed in future writings, as will the recent promising renewal of the focus on rules.