Central Bank Independence Is Not Enough

Four former chairs of the Fed  wrote in the Wall Street Journal today about the importance of Fed independence. I agree, but their article should have emphasized that independence is not enough.  Economic performance has been affected by large shifts between more rules-based and less rules-based policy by the Fed without any concomitant change in the legal basis for independence. De jure independence has not prevented the Fed from harmful departures from rules-based policies.

The absence of a rules-based policy at the Fed in the 1970s was accompanied by high inflation and high unemployment. The move to rules-based policy during the two decades starting in the early 1980s was accompanied by improved price stability and output stability. And a move away from rules-based policy starting around 2003-2005, was followed by poor economic performance including the Great Recession and the Not-So-Great Recovery, as shown in this article in Swedish Riksbank Economic Review

There, of course, have been swings in de facto independence. For example, the Fed sacrificed its de facto independence in the late 1960s and 1970s and regained it in the 1980s and 1990s. There is a close correlation between de facto independence and rules-based policy.

But within a given legal framework, the Fed has engaged in varying degrees of adherence to rules-based policy. We have seen major shifts in the effectiveness of monetary policy within a single framework of central bank independence. Monetary policy needs to focus more on ways to encourage more rules-based policy as well as on ways of maintaining independence.

Posted in Monetary Policy

Africa Meeting of Econometricians: History, Revival and Ways Forward

I just spent a wonderful few days at the 2019 Africa Meeting of the Econometric Society held in Rabat, Morocco with the central bank, the Bank Al-Maghrib, providing an excellent venue.  Congratulations to the Bank Al Maghrib for its 60th anniversary year and also to the Econometric Society for its upcoming 90th anniversary in 2020.

One sees positive economic changes coming to this part of Africa, and it is good that the Econometric Society is meeting here. Morocco is looking to join the Economic Community of West African States (ECOWAS) which includes, among other countries, Nigeria, Senegal, Côte d’Ivoire, Ghana, Liberia, Mali, Niger, Benin and Togo. I have travelled to these countries and worked on the US-Moroccan Free Trade Agreement a while back. The idea of an expanding free trade zone is breathtaking especially if combined with other pro-growth reforms. The Bank Al-Maghrib has widened the exchange rate band and capital controls are gradually being relaxed. Several years ago, I spoke in Casablanca about the promise of economic reform, and now it seems to be underway.

But most of all I was impressed by the many sessions of the Econometric Society which demonstrate how economic ideas are spreading throughout the region and the world. The latest econometric methods were evident throughout.  So was big data. One paper examined export and import data in Malawi from 219 countries, with tens of thousands of observations. Another examined the impact on net interest margins of 2,442 banks affected by negative interest rates. This transmission and global conversation is in marked contrast to days when I started out in econometrics, long before there were African meetings of the Econometric Society. It bodes well for the spread of technology generally as a means to improve people’s lives.

My keynote address at the conference delved into the history of the use of econometric models for monetary policy going right up to what has happened in the past few months.  I started out with “path-space” models such as the Tinbergen model which looked at the impact of different paths of the instruments on target variables.  Then “rules-space” approaches began with a major paradigm shift, and central bank models changed for the benefit of policy and performance. Then there was a retrogression, at least in major parts of central banking world, as central banks deviated away from more rules-based approaches, and economic performance deteriorated in the global financial crisis. The lesson learned from history is that we need to get back to rules-space.  Now, just in time, there is a revival of policy rules research, evident in papers, publications, actions, and statements by Fed officials and other central bankers.

The history shows that there are important benefits from a rules-based monetary policy, while it lasts, and that even expectations of a return to rules has benefits. The recent changes in research are promising, as are the other developments in Africa.  What can econometricians do to prevent the deviations and encourage rules-based policy. How can econometric research ideas help? My suggestions at the meeting included more robustness studies on different models and parameters, more development and use of international models to evaluate rules, more research with “quantitative easing” as an instrument in a rule, and a greater focus on the interface between research on rules in central bank research departments and the decisions of central bank policy officials.

Posted in Financial Crisis, Monetary Policy

A Decade of July 4th Debt Explosions: Are They Getting Less Spectacular?

Starting a decade ago, I’ve charted on Independence Day the most recent long-term projection of the federal debt by the Congressional Budget Office (CBO). Over the years the chart has continued to look much like the Fourth of July fireworks, as you can see here 2010, 20112012, 2013, 2016, 2017, 2018 .

The CBO just released its 2019 Long-Term Budget Otutlook  on June 25, and so it’s time for a July 4th update. The chart of the total deficit on the front cover of the report (reproduced here) is a sight to behold.  As CBO says: “If current laws generally remained unchanged, large budget deficits would boost federal debt to unprecedented levels over the next 30 years.”

What about the debt? I plotted in the next chart the forecast of the debt as share of GDP (solid blue line) along with the forecast of net interest payments on the debt as a share of GDP (dashed red line) and, for comparison, the debt as a share of GDP (solid red line) as projected through 2047 by the CBO in March 2017 before the Tax Cuts and Jobs Act of 2017.

The message, like the fireworks display, is still loud and clear: The debt is exploding, and net interest payments are rising rapidly as a share of GDP. No new news here.

But there are two pieces of news in the debt chart. First, the debt is now projected to be 11 percentage points lower as a share of GDP in 2047 compared to the projection at this time last year. That’s an improvement. Second, the 2017 Tax Act did not increase the debt to GDP ratio going forward: The projected trajectory of the debt to GDP ratio is lower after the tax cut than before, except for a small increase at the start of the projection.  The debt problem is still due to rising spending growth not the tax reform. Maybe less spectacular, but no reason for complacency.

Posted in Budget & Debt, Fiscal Policy and Reforms

Recent Decisions and Rules of the Fed

Last week, after attending monetary policy conferences at Stanford, Chicago and Frankfurt, I put forth evidence in EconomicsOne.com of a revival of research on monetary policy rules for the instruments, whether at the conferences, in research papers, or in Fed publications. I offered possible explanations for the revival, also with evidence, including revealed preference by policymakers, the need to deal with the effective lower bound, disappointments with past departures from rules, threats of legislation, and concerns about political pressure.

This week, Peter Ireland posted an article with a carefully worked-through analysis of recent actual monetary decisions, which takes the idea of the Fed using policy rules for the instruments a significant step further, well beyond research papers and into policy arena.

In the article, entitled A Rule That Makes Sense of the Fed, Peter examines recent changes in the Fed’s interest rate target, and he shows they are consistent, according to the Taylor Rule, with changes in real GDP, inflation, and r-star. Going line-by-line through the table below (which I draw from his article)

he shows the Fed’s Summary of Economic Projections (SEP) and demonstrates how a change in the federal funds rate from September 2018 to June 2019 can be explained, via a Taylor Rule, by changes in real GDP, the core PCE inflation rate, and r-star over the same period.

Peter thereby demonstrates that the Fed could be more explicit that these decisions are rules-based. In this way, he shows that “policymakers could explain more easily that the substantial downward adjustment to their expected interest-rate path represents a deliberate response to changes in their outlook for economic growth and inflation, together with their best judgement that r-star is considerably lower than previously thought. Even more important, they could use the Taylor Rule to demonstrate that their interest rate decisions are driven by economic analysis alone and not influenced by political pressure.”

It is another reason for Fed policymakers and other central bank official to strive to make their decisions within a rules-based framework, which can be analyzed with economic models, checked for robustness, and integrated internationally.

Posted in Monetary Policy

Let’s Twist Again with Online Econ 1

This summer we will be offering Stanford’s Principles of Economics course online.  As explained in this Wall Street Journal article, “A Twist in Online Learning at Stanford,” the twist again is that we’ll offer it both (1) to the general public and (2) for credit to matriculated Stanford students, incoming freshman, and visiting students in the Stanford Summer School.

Those seeking credit can register here for the for-credit course, which is just starting with the first week’s videos and other course content posted on Monday, June 24. This is the same as the on-campus course, Economics 1, which I give at Stanford during the academic year, and it fulfills all the same requirements. Getting credit requires regular homework, a mid-term exam, and a final exam, all of which are taken online.

The open online course for the general public is also based on my lectures in the on-campus Stanford course. It begins one week later, on July 1, and next week information will available here. People who participate in the open online course and take the short quizzes following each video will be awarded a Statement of Accomplishment, or a Statement of Accomplishment with Distinction.

The on-line courses cover all of economics at a basic level.  They stress the key idea that economics is about making purposeful choice with limited resources and about people interacting with other people as they make these choices. Most of those interactions occur in markets, and this course is mainly about markets, including the market for bikes on campus, or labor markets, or capital markets.  We will show why free competitive markets work well to improve people’s lives and how they have removed millions from people from poverty around the world, with many more, we hope, still to come.

The textbook for the course is Principles of Economics by John B. Taylor and Akila Weerapana and it is available online as well

I am looking forward to another great summer quarter. Here is a sampling of views about the online course, either for the general public or for credit, which have been posted on Twitter:

  • Russell Roberts‏ @EconTalker: Great class. Great teacher. No charge. Get your basics right here.
  • Ike Brannon‏ @coachbuckethead: The most entertaining economist I know.
  • Brian Wesbury‏ @wesbury:  If you want to learn Economics from one of the best, click on this link!  What great news!
  • Juan Carlos Martinez‏ @juank700410: Educación gratuita y de calidad
  • Tom Church @TomVChurch Interested in economics? Take Econ-1 online. Pass the quizzes and get a statement of accomplishment! Plus, you’ll learn a thing or two.
  • Chris Pippin @ChrisPippin This is the class and the professor that made me an Econ major. Thanks to the generosity of @EconomicsOne and the miracle of the internet, now anyone can take it.
  • Nicolas Petit  @CompetitionProf Great course by terrific teacher, comprehensive & more than all eye opening on real world problems like trade wars and monetary policy.


Posted in Teaching Economics

A Revival of Research on Monetary Policy Rules for the Instruments

Recently I had the opportunity to participate in several conferences on monetary policy: the annual Hoover monetary policy conference at Stanford in May, the 2019 Fed Review conference in Chicago in June, and the Macro Model Comparison Conference in Frankfurt also in June.  There are many takeaways, but one was very evident.  I will call it a “Revival of Research on Monetary Policy Rules for the Instruments.” Policy rules were the subject of much research in the 1970’s, 1980’s and 1990’s, but in recent years there was a lull.  Now there’s a big pickup. Here are some examples, with the many links found at the conference web pages.

At Stanford, Mertens and Williams (2019) evaluated different interest rules with a new Keynesian model and Cochrane, Taylor and Wieland (2019) evaluated rules with seven different models. In Chicago, Sims and Wu (2019) evaluated different monetary policy rules with a new structural model, and Eberly, Stock and Wright (2019) evaluated monetary policy rules using the FRB/US model. In Frankfurt, Andreas Beyer (2019), Gregor Boehl (2019) and many others evaluated interest rate rules in specific models, and Nikolsko-Rzhevskyy, Papell and Prodan (NPP) (2019) compared policy rules with discretion historically using new econometric techniques. NPP considered a specific policy rule for the interest rate and measured discretion as deviation of actual interest rate from that rule. They did calculations for 400 rules and found that the average loss in high deviation periods was greater than the average loss in low deviations periods.  They also noted that “inflation-tilting” rules result in better performance. This matrix summarizes their results.

And the evidence goes beyond these conferences. Some have looked at other instruments such as the money supply, including Belognia and Ireland (2019), but most others continue to look at interest rate instruments. Bernanke, Kiley and Roberts (2019) examined ten different monetary policy rules for the instruments using the FRB/US model. The ten interest rate rules are in this table:

And a whole new section on monetary policy rules for the instruments appeared in the Fed’s Monetary Policy Report (2019) with five different policy rules presented and compared with actual policy. This is the fourth time in a row that such explicit discussion of rules has appeared in the Report effectively in real time. Here are the rules:

What explains the revival?  One explanation is simply a revealed preference for such research on the part of monetary policy officials and others interested in monetary policy making. At the Chicago Fed conference, Cecchetti & Schoenholtz (2019) found “The most frequently mentioned topic is the desirability of having a clear understanding of policymakers’ reaction function.” And there are statements by central bank leaders: including Raghu Rajan, former governor of the Reserve Bank of India, “what we need are monetary rules,” Mario Draghi: “we would all clearly benefit from…improving communication over our reaction functions…”  and Jay Powell “I find these rule prescriptions helpful”

Another explanation is the desire to figure out how to deal with the effective or zero lower bound on the interest rate. There is genuine concern at the Fed about the lower bound in the case of a need for substantial easing. How else can one evaluate alternative proposals for “lower for longer” policy, such as the Reifschneider-Williams proposal, than with a rule?  This is a huge motivation behind the work presented by Lilley and Rogoff (2019) and Bordo and Levin (2019) at the Hoover monetary conference.

Another explanation is the disappointment with monetary policy leading to great recession and especially the deviation from rules in the 2003-2005 “too low for too long” period.

Another explanation is the recognition that we need rules to evaluate quantitative easing proposals. At the Chicago conference, Brian Sack (2019) said “‘Talking more about the policy rules…is appropriate’ to guide future bond purchase programs and improve their impact.”

Perhaps concern about the proposed Policy Rules Legislation in Congress in 2017-18 led the Fed to talk more openly about policy rules in the Monetary Policy Report.

And finally, there are more people kibitzing about policy, but often without a monetary framework. Rules-based policy analysis provides an explicit and accountable answer to those critics.

There are key features of the revival: Monetary policy rules are usually stated in terms of policy instruments. Generally, they are not “forecast targeting,” which is specific about the goals, such as 2% inflation, but not about the policy instruments.   There are very few rules which assume the instrument is QE. An exception is Sims and Wu (2019), who propose a Taylor rule for QE. Perhaps this aversion to rules with QE is due to doubts about impact of QE.  Bordo and Levin (2019) say that “Our empirical analysis indicates that QE3 was not an effective form of monetary stimulus,” and Hamilton (2019) argues that QE had little effect.

Another feature is that recent policy rule research, such as in Fed’s Monetary Policy Report, assumes the Taylor principle with the coefficient on inflation greater than 1. As stated in the Report:  “One key principle is … the policy rate should be adjusted by more than one-for-one in response to persistent increases or decreases in inflation.

To sum up, there is evidence of a revival of research on rules for the policy instruments whether at conferences, in research papers, and in Fed publications. Possible explanations include revealed preference by policymakers, the need to deal with the effective lower bound, disappointments with past departures from rules, and threats of legislation.

Thus far there has been little work on policy rules with QE as the instrument, perhaps because of doubts about the effect of QE. In any case, there is a great need in this revival for more robustness studies and for international monetary models.

Posted in Uncategorized

Currencies, Capital, Central Bank Balances — 5th in a Series

The most recent book, Currencies, Capital, and Central Bank Balances, in a series on monetary policy has just been published. As the line-up of covers below shows, it is the 5th in a series of volumes emerging from conferences on monetary policy held each spring at the Hoover Institution. The series started during the Federal Reserve Centennial. The conferences at that time did not, in our view, portray a full range of views about policy. So we decided to start a conference series with a bigger range of views, and it has been popular. Next May 3 we will have the 6th conference and a book will likely emerge.

Currencies, Capital and Central Bank Balances focuses on several pressing issues in monetary policy with a tilt toward international issues. One issue concerns the international flow of money and capital and exchange rate volatility.  The key policy question is whether the IMF’s increasing use of capital flow management through government restrictions on cross-border flows can reduce capital flow and exchange rate volatility without creating growth-reducing market distortions and other sources of instability. Jonathan Ostry of the IMF argues for such controls, while Sebastian Edwards points out the problems. In my paper I argue that a rules-based international system of monetary policies is a better approach.

Another policy issue is the size of central bank balance sheet and its use as a separate monetary policy instrument in addition to the interest rate. The key question is whether central bank balance sheets should stay large or whether they should be reduced to a level in which interest rates are market-determined. Lorie Logan, Mickey Levy, Bill Nelson and Peter Fisher all weight in on the issue.

These issues are related because central bank balance sheet operations affect exchange rate and capital flow volatility. Both issues are currently on the policy agenda. The G20 Eminent Persons Group just made recommendations about policy toward capital flows, and the Fed is now making key decisions about the ultimate size of its balance sheet.

The book can be down loaded or purchased. There is much to be learned from  the many contributors including policy makers, academics and market participants: Adrien Auclert, Raphael Bostic, John Cochrane, Sebastian Edwards, Peter Fisher, Esther George, Gita Gopinath, Oleg Itskhoki, Robert Kaplan, Mickey Levy, Lorie Logan, Prachi Mishra, Bill Nelson, Jonathan Ostry, Kyle Palermo, Monika Piazzesi, Charles Plosser, Randy Quarles, Raghuram Rajan, Tom Sargent, Martin Schneider, George Shultz, Paul Tucker, Kevin Warsh, and  John Williams.


Posted in Uncategorized