Janet Yellen visited San Francisco and Stanford last week. She gave two interesting talks about monetary policy, which together, in my view, break new ground, and are worthy of more discussion.
At the Commonwealth Club in San Francisco she briefly described the Fed’s monetary strategy for the policy instruments. At the Stanford Institute for Economic Policy Research she compared the Fed’s recent monetary policy with the Taylor rule and closely related monetary policy rules.
If you view these two talks together, I think they resemble what would be required under the Requirements for Policy Rules of the Federal Open Market Committee, Section 2 of the Fed Oversight Reform and Modernization (FORM) Act which has passed the House of Representatives. That legislation requires that the Fed (1) “describe the strategy or rule of the Federal Open Market Committee for the systematic quantitative adjustment” of its policy instruments and (2) compare its strategy or rule with a reference rule. More detail here.
Let me explain why the two talks represent progress in both directions. In the San Francisco talk, Janet Yellen summarized the Fed’s strategy for the policy instruments, saying that
“When the economy is weak and unemployment is on the rise, we encourage spending and investing by pushing short-term interest rates lower. As you may know, the interest rate that we target is the federal funds rate, the rate banks charge each other for overnight loans…. Similarly, when the economy is threatening to push inflation too high down the road, we increase interest rates to keep the economy on a sustainable path and lean against its tendency to boom and then bust.” She then described “price stability” as a level of inflation of “2 percent a year,” the maximum level of employment that can be sustained in the longer run as an unemployment rate of around 4-3/4 percent, and a “longer-run neutral rate” of the federal funds as a rate of “3 percent.”
One could certainly add more detail, but the statement includes the signs of the responses by the policy instruments, though not the magnitudes; it mentions key factors driving the responses; and it gives numerical values for three key parameters. It could be usefully added, as is, to the Fed’s Statement on Longer-Run Goals and Monetary Policy Strategy, which, despite its name, now has no strategy for the instruments, only goals.
Next consider the Stanford talk which was loaded with charts and references to the Taylor rule and other policy rules. The purpose was to compare actual Fed policy with the Taylor rule, which she states, “embodies key principles of good monetary policy,” and then explain any differences. People found that useful, and it was good to see clarification of how the FOMC uses such policy rules in a constructive manner. That’s the kind of comparison that is required in the legislation that passed the House. My question to her at the talk (see here) was meant to explore the possibility that such a presentation could satisfy the legislation, but in her answer she still expressed opposition to the legislation. Nevertheless, I think further discussion of the issue would be useful. There are more similarities than differences between the type of presentation given by Janet Yellen in California last week and the type of presentation required by the FORM Act, suggesting that a compromise might be feasible.
To be sure, the description of the policy strategy and the comparison of policy with the reference rule took place in two different talks. If presented in the same talk the analogy with the requirement under the legislation would be easier to make. Janet Yellen frequently uses footnotes for algebraic descriptions in her talks. If she added another footnote, an algebraic way to summarize the words used in San Francisco might be:
r = p + ay + b(p – 2) + 1
with a > 0 and b > 0, where r is the federal funds rate, p is the rate of inflation, and y = 2.3(4.75-u) where u is the unemployment rate. (The 2.3 comes from Janet Yellen, Remarks, April 11, 2012)
In contrast the reference rule (Taylor rule) is:
r = p + .5y + .5(p – 2) + 2
So the comparison is pretty obvious.
In listening to Janet Yellen’s talk I was reminded that I invited Alan Greenspan to give a talk to the same research group at Stanford 20 years ago in 1997 when I was the director. He came, and he chose as the topic, Rules vs. Discretionary Monetary Policy. He discussed the Taylor rule, about which he listed “a number of attractive features” and commented on the usefulness of monetary policy rules in general. The experience with monetary policy, both when it is rules-based and when it is not rules-based, in the United States and other countries during the past 20 years provides much useful information about how to improve monetary policy going forward. Talks such as Janet Yellen’s and further discussion about them will further this important goal.