This week the Federal Reserve Board posted for the first time its FRB/US policy evaluation model and related explanatory material on its website. This new transparency is good news for researchers, students and practitioners of monetary policy.
Making the model available finally enables people outside the Fed to replicate and critically examine the Fed’s monetary policy evaluation methods, one recent example being Janet Yellen’s evaluations of the Taylor rule that she reported in speeches just before she became chair. This makes it possible to understand the strengths and weaknesses of the methods, compare them with other methods, and maybe even improve on them.
The ability to replicate is essential to good research, and the same is true of good policy research. Such replication was not possible previously for the Fed’s model, as I know from working with students at Stanford who tried to replicate published results using earlier or linear versions of FRB/US from Volker Wieland’s model data base and could not do so.
Having the model should also enable one to determine what the “headwinds” are that Fed officials so often say requires extra low rates for so long? It will also explain why some Fed staff thinks QE worked, or why they argue that the income effects of the low interest rate do not dominate the incentive effects on investment.
The Fed’s FRB/US model is a New Keynesian model in that it combines rational expectations and sticky wages or prices. But it can also be operated in an “Old Keynesian” mode by switching off the rational expectations, as when it was used in a paper by Christina Romer and Jared Bernstein to evaluate the 2009 stimulus package. For professors who teach about monetary policy evaluation in their courses it will be interesting and useful to show students how the Fed’s New Keynesian model differs from other New Keynesian models.
The newly posted material also clarifies important technical issues such as how the Fed staff has been solving their model in the case of rational expectations. We now know that they have been using the computer program Eviews, but we also learn that rather than the solution method built into Eviews (which is the Fair-Taylor algorithm) the Fed staff has used a different version of that algorithm. This is important because solution methods sometimes give different answers.
It is easy to criticize practical workhorse models like the FRB/US model, but as New Keynesian models go it’s OK in my view. In his review in the Wall Street Journal blog, Jon Hilsenrath criticizes the Fed’s model because “it missed a housing bubble and financial crisis,” but I don’t think that was simply the model’s fault. Rather it was due to policy mistakes that the model, if used properly, might have avoided. And models which included a financial sector or financial constraints do not do any better. We will see how the new models being built now do in the next crisis.