15. Which Rule for Monetary Policy?

Transcription

1 15. Which Rule for Moneary Policy? John B. Taylor, May 22, 2013

2 Sared Course wih a Big Policy Issue: Compeing Moneary Policies Fed Vice Chair Yellen described hese in her April 2012 paper, as discussed in he firs lecure R = 2 + π + 0.5(π - 2) + 0.5Y, R = 2 + π + 0.5(π - 2) + 1.0Y wih Y = 2.3(5.6-U ), And hey ve been discussed for a leas 10 years a he Fed, as evidenced by Jan 2002 meeing Though similar in some respecs, he ineres rae differences are huge:

3 and one gives a raionale for QE and forward guidance. year

4 Tesimony in Senae Banking Commiee: March 1, 2011 MR. BERNANKE:... The Taylor Rule suggess ha we should be, in sense, way below zero in our ineres rae, and herefore we need some mehod oher han jus normal ineres rae changes o -- SEN. TOOMEY: Do you know if Mr. Taylor believes ha? MR. BERNANKE: Well, here are differen versions of he Taylor Rule, and here's no paricular reason o pick he one ha he picked in In fac, he preferred a differen one in 1999 which, if you use ha one, gives you a much differen answer. SEN. TOOMEY: My undersanding is ha his view of his own rule is ha i would call for a higher Fed funds rae han wha we have now. MR. BERNANKE: There are, again, many ways of looking a ha rule, and I hink ha ones ha look a hisory, ones ha are jusified by modeling analysis, many of hem sugges ha we should be well below zero. And I jus would disagree ha ha's he only way o look a i. Bu anyway, so I hink here are some -- here is some basis for doing ha.

5 Compare and conras he wo policies. Which would you recommend? Explain using heory and facs from he course. There are many similariies policies are rule-like ineres rae is he insrumen wo variables affec policy decisions weigh on oupu is posiive weigh on inflaion is greaer han one boh are simple rules There are wo big differences; The esimae of he oupu gap The size of he coefficien on he gap So we mus consider boh of hese in deail

6 Differences in he size of he gap The second rule uses an Okun s law o ge he gap I uses a coefficien of 2.3 Wih U=8.1, he gap is hus 2.3(5.6 U) = 5.8 Bu his 2.3 coefficien is larger han empirically esimaed values Regression esimaes find a coefficien of 1.5 see regression able Using his regression he gap would be much smaller (8.1) = 3.2 In conras, he firs rule does no use he unemploymen rae o esimae he oupu gap; For example, consider he CBO esimae of he gap This is also much smaller han he second rule See char HP filered esimae of he gap is even smaller

7 Okun s Law regression Dependen Variable: CBO s esimae of oupu gap Mehod: Leas Squares Sample: 1955Q1 2011Q4 Variable Coefficien Sd. Error Consan Unemploymen Rae R 2 = 0.81 Mean of dependen variable = 0.48 S.D. of dependen variable = 2.64 S.E. of regression =1.15 Durbin Wason saisic = 0.32

8 Two esimaes of he gap Percen percenage poin difference in percenage poin difference in gap from CBO -4-6 gap from Fed

9 Even bigger difference if you use HP filer o derend! (Slide 11, Lecure 2)

10 Thus he second rule seems o assume a gap which is oo large. And here is more evidence Table from Updae of How Big is he Oupu Gap? Jusin Weidner and John C. Williams, July 7, From Fed s unemploymen based mehod Also uncerain: Sandard deviaion = 1.8

11 Difference in he coefficien on he gap 0.5 or 1.0? Smaller coefficien more robus; see chars in Taylor Williams survey (Slide 7, Lecure 12) Experience from shows problems wih larger coefficien on oupu (see evidence in char) Smaller coefficien beer because of oupu gap uncerainy Poenial GDP hard o measure Examples from 1970s (Ahanasios Orphanides) Frank Smes esimaes You run ino he lower bound less ofen wih smaller coefficien And hus unpredicable acions like QE occur less ofen =2 (raher han zero) is chosen o deal wih he problem In any case use augmened rule raher han QE Experience (e.g. Japan) shows ha a downward spiraling deflaion is no a problem in pracice

12 Fuhrer Woodford Rudebusch Svensson (Slide 7, Lecure 12)

13 Exension of DiClemene char back o earlier years Percen 8 6 Raes would no have sayed down for so long wih his rule: Boom bus no so severe? federal funds rae Taylor Yellen

14 Source: Frank Smes: Oupu Gap Uncerainy: Does i Maer for he Taylor Rule BIS Working Paper, No. 60, November 1998 Recall S.D.1.8 across survey of esimaes

15 Forward Guidance Explained Simply

16 rule rule i i d d d d d Z Z i i... where,0) max( Augmened rule for he zero lower bound : Forward Guidance in Theory

17 Forward Guidance in Pracice Firs formulaion i = 0, if 2015 i =?, if > 2015 New formulaion i = 0, if u 6.5% as long as π 2.5% i =?, if u < 6.5% One guess abou? or happens afer zero is a reurn o eiher Rule 1 or Rule 2. Bu here a ime inconsisency problem

18 An alernaive and much simpler approach would enail seing he federal funds rae according o he prescripions of a policy rule, such as he well-known Taylor rule or a varian. Many sudies have shown ha, in normal imes, when he economy is buffeed by ypical shocks--no he exraordinary shock resuling from he financial crisis--simple rules can come prey close o approximaing opimal policies. why shouldn he FOMC adop such a rule as a guidepos o policy? The answer is ha imes are by no means normal now, and he simple rules ha perform well under ordinary circumsances jus won perform well wih persisenly srong headwinds resraining recovery and wih he federal funds rae consrained by he zero bound. Jane Yellen, November 2012

19 Conclusion The wo policies share many characerisics hese are wha economic heory and facs would recommend. Regarding he differences, heory and facs imply a more robus (smaller now) esimae of he gap a smaller coefficien on he gap Of course one could argue he oher side and, if argued well, ge a good grade! Two asides: i s wonderful o have such an imporan and pracical problem a he cener of 1 s year Ph.D. curriculum Beware of wolves in sheep clohing, or, in his case, discreion in rules clohing