Everyone keeps asking about this year’s Jackson Hole monetary conference and how it compared with the first. Well, I wrote about the first on my way to this conference, and I have to say the thirty fifth lived up to its billing as “monetary policy frameworks for the future.” One speaker after another proposed new frameworks—some weird, some not so weird—while discussants critiqued and central bankers and economists debated from the floor, and later on the hiking trails. Steve Liesman’s scary but unsurprising CNBC pre-conference survey demonstrated the timeliness of the topic: 60% of Fed watchers don’t think the Fed even has a policy framework.
Fed Chair Janet Yellen led off. Most of the media commentary—including TV interviews—focused on whether or not she signaled an increased probability of an interest rate rise. But mostly she talked about the theme of the conference: a monetary policy framework for the future. The framework that she put forward centered on a policy rule for the interest rate—a Taylor rule with an equilibrium rate of 3 percent—and in this sense the framework is rules-based with well-known advantages over discretion. Research at the Fed indicates that the rule would work pretty well without an inflation target higher than 2% or a mechanism for negative interest rates. But for an extra big recession when a zero lower bound might be binding for a long time, Chair Yellen suggested adding two things to the rule.
First, she would add in some “forward guidance” in which the Fed would say that the interest rate would stay at zero for a time after the rule recommended positive following a very deep recession during which the rule would otherwise call for a negative rate. The forward guidance would be time consistent with the actual policy, so in this framework the Fed would not be saying one thing and doing another. You can see this in the upper left panel of this chart which was part of her presentation.
Note that the federal funds rate with forward guidance is actually quite close to the constrained rule without forward guidance. This framework essentially follows the suggestion of Reifschneider and Williams (1999) to embed the Taylor rule into a “mega rule,” so in this respect also the framework is rules-based.
Second, Chair Yellen would augment the policy rule with a massive ($2 trillion) quantitative easing in an effort to bring long-term interest rates down. Here her chart suggests big effects on long-term interest rates, though empirical evidence for this is very weak. This is a “QE forever” framework. It would require a large balance sheet going forward with the funds rate determined administratively by setting interest on excess reserves, with the size of the quantitative easing determined in a discretionary rather than a rule-like fashion. The chart indicates only a small improvement in the unemployment rate, and there is a danger that such a discretionary policy could itself help cause instability and high unemployment as in the great recession. It is good, however, that the discretion is measured relative to a policy rule with an implicit understanding of a return to the rule.
Many other speakers talked about the size of the central bank’s balance sheet, and views were all over the place. Ulrich Bindseil of the ECB argued for eventually returning to a “lean” balance sheet. This is a good goal because the central bank would then remain a limited purpose institution which is appropriate for an independent agency of government. Simon Potter of the New York Fed argued for a large balance sheet so the Fed had more room for interventions. Jeremy Stein, Robin Greenwood, and Samuel Hanson made a good case for more short-term Treasuries to satisfy a liquidity demand, but a much less convincing case that a large balance sheet at the Fed rather than additional Treasury issuance was the way to achieve this. In his lunch time talk Chris Sims also noted the problem with the Fed having a large footprint extending into fiscal policy where an independent agency of government is not appropriate. My Stanford colleagues Darrell Duffie and Arvind Krishnamurthy warned about diminished pass-through from policy rates to other interest rates in the current regulatory environment with supplementary liquidity and capital requirements; they did not see the pass-through any faster or complete with lean balance sheet.
Ricardo Reis argued in favor of a balance sheet more bloated than the lean proposal of Bindseil but not as big as the current one in the US with the Fed following a Taylor rule by changing interest on reserves. Benoít Coeuré of the ECB spoke about the continued QE and growing balance sheet at the ECB; while recognizing international spillovers, he argued that the policy was working. Haruhiko Kuroda of the Bank of Japan made the case for QE as well, though the economic impact in Japan is hard to find. The sole representative of emerging markets on the program, Agustín Carstens, Governor of the Bank of Mexico, made the case for a classic inflation targeting framework, and showed that it was working just fine in Mexico.
Negative interest rates were also a frequent topic. Marvin Goodfriend made the case with a simple neoclassical model and suggestions for dealing with cash, and Miles Kimball intervened several time to support the case. Kuroda showed that the BOJ’s recent sub-zero foray had a large effect on the long term rate and gave a good explanation why, but he lamented the lack of an effect on the Japanese economy. However, Chair Yellen and other Fed participants showed little interest at this time, which made sense to me.
A Framework that Works
One monetary policy framework that was not on the program for Jackson Hole XXXV (but was emerging at Jackson Hole I) was the framework in operation during the 1980s, 1990s and until recently—during Volcker’s and much of Greenspan’s time as chair. It was a monetary policy framework that worked according to historians and econometricians until the Fed went off it and things did not work so well. That suggests it would be a good candidate for a future framework.