Taking Stock at the Fed

Yesterday and today, three economists (Andrew Levin, Chris Erceg and Mike Kiley) who work on the staff of the Federal Reserve Board graciously hosted a big gathering of monetary economists from around the world. The get together was held on the top floor of Fed’s office building in Washington DC overlooking the Mall. Its purpose was to take stock of key research developments in monetary theory and policy over the past few years. For example, John Williams of the San Francisco Fed and I flew in from California and reviewed recent research on monetary policy rules. All the papers will eventually be published in a new Handbook of Monetary Economics.

The meeting demonstrated how completely wrong Paul Krugman is about recent developments in economics, at least as he portrayed the subject in the New York Times Magazine last month. This was not an all efficient markets meeting. The talk from start to finish was about the market imperfections, price rigidities, deadweight losses due to market power, and imperfect information, which all occur in monetary economics. If anything there was too much focus on market distortions. Overall I saw tremendous progress documented at the meeting. The presentation by my Stanford colleague Pete Klenow and his coauthor Ben Malin, for example, reviewed the impressive volume of empirical research on firm price setting decisions using new BLS data sets. Their discussant Marty Eichenbaum pointed to even more of this kind of research, which solidifies and bolsters the type of monetary theory that has been developed in recent years.

But if there has been so much progress in monetary economics, then why did we have the financial crisis? I argued that it was the policy, not the economics, which got off track. When the policy implications of the research were followed by policy makers, we had good economic performance, as in the period called the Great Moderation. When policy got off track, the Great Moderation ended in the financial crisis and Great Recession. I am hoping that policy will get on track again and we will have Great Moderation II.

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