Comment on John Taylor: Rules Versus Discretion: Assessing the Debate over the Conduct of Monetary Policy

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Jemimah Bradford
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1 Cmment n Jhn Taylr: Rules Versus Discretin: Assessing the Debate ver the Cnduct f Mnetary Plicy Octber 13th, 2017 Dnald Khn Rbert V. Rsa Chair in Internatinal Ecnmics Senir Fellw, Ecnmic Studies The Brkings Institutin

2 Primacy f Objectives Plicymakers shuld be held accuntable primarily fr achieving legislated bjectives. Granted high degree f instrument independence in hw t d s: Enables lnger-term perspective relative t elected representatives. Central bank needs t explain hw its instrument setting relates t legislated bjectives. What shuld be the rle f rules in fstering prgress tward bjectives and in explaining instrument chices. 2

3 Khn and Taylr Differences [Rules] tend t use frmulas r equatins fr the plicy instrument, at least as a guide when making decisins. And the decisins abut the plicy instruments can be described reasnably well by a stable relatinship which shws a cnsistent reactin t bservable events (pp.19-20). Degree f Presumptin; Rle f Predictin: Taylr: Lk first t an algebraic rule, usually based n a small number f variables, that desn t vary ver time; deviatins frm the algebra r new frmulatins--are unusual (therwise it wuldn t be a rule) and require very strng ratinale. Rely mstly n current estimated values f utput and inflatin gaps and r*. Khn: Algebraic rules are reference pints t be used in thinking abut and explaining plicy strategy, but in a cmplex, ever changing and prly understd ecnmy, the presumptin fr fllwing an algebraic rule clsely is weak and the apprpriate reference rule can change. Predictin using all infrmatin is essential t gd plicy. Mike Tysn and Dwight Eisenhwer 3

4 The Glden Age f Rules: Irny: Plicymakers weren t trying t fllw a rule. What were they ding: Fcusing n cntaining and reducing inflatin fllwing Taylr principle but nt in a rule-based manner. Paying clse attentin t utput and emplyment and their relatinship t inflatin, with sme skepticism abut gap measurement. Cnscius f plicy lags, they were trying t anticipate the future, using every scrap f infrmatin, and emplying risk management. Making allwance fr shifting relatinships f plicy rate t financial cnditins affecting utput gaps. Bringing diverse views t their deliberatins. 4

5 Stability and utility f stable relatinship f instrument settings t bservable events requires knwledge and stability f underlying values and relatinships. Values f the unbservables: y*, u*, r* Relatinships: r and y-y*; y-y* and π Great Mderatin; NICE perid Falling prductivity and labr frce grwth. Declining r* and damped respnse t accmmdatin. Very lw inflatin, threat f deflatin, changing relatinship f π t y-y*. Huge changes in the financial system that transmits plicy impulses. Lng stretches with plicy rates cnstrained by ELB. 5

What are the prblems rules advcates are trying t slve? Pr Outcmes: Slw recvery, lw inflatin. Accuntability: Imprving cngressinal versight. Uncertainties: Helping peple understand Fed actins.

6 What are the prblems rules advcates are trying t slve? Pr Outcmes: Slw recvery, lw inflatin. Accuntability: Imprving cngressinal versight. Uncertainties: Helping peple understand Fed actins. Mnetary Plicy /1/1985 5/1/1986 9/1/1987 1/1/1989 5/1/1990 9/1/1991 1/1/1993 5/1/1994 9/1/1995 1/1/1997 5/1/1998 9/1/1999 Surce: Ecnmic Plicy Uncertainty US Plicy Categries - Categrical EPU Data. Retrieved frm: 1/1/2001 5/1/2002 9/1/2003 1/1/2005 5/1/2006 9/1/2007 1/1/2009 5/1/2010 9/1/2011 1/1/2013 5/1/2014 9/1/2015 1/1/2017 Surce: Olsn, Peter and David Wessel Federal Reserve Cmmunicatins: Survey Results. Hutchins Center n Fiscal and Mnetary Plicy at Brkings. Retrieved frm:

7 Enhanced Rle fr Rules: Align Public with Private Use Nt the FORM Act: Strng presumptin f fllwing an algebraic rule. Invlving GAO arm f Cngress fr changes r deviatins. If FOMC s hands had been tied by FORM Act and its sand in the gears f respnding t unprecedented ecnmic and financial develpments, utcmes wuld have been further frm legislated bjectives. Can have a strategy withut fllwing a rule: Hw expect t achieve bjectives; hw might respnd t shcks under different circumstances But need t explain as well as pssible. Rules can be useful fr explicatin f strategy t enhance understanding and accuntability: Anther way t articulate strategy ratinale: Where is plicy setting relative t suite f rules (MPR bx)? Why? (nt in bx) Culd help understanding and evaluatin f plicy decisins. 7

Internal vs. external validity. External validity. This section is based on Stock and Watson s Chapter 9.

Sectin 7 Mdel Assessment This sectin is based n Stck and Watsn s Chapter 9. Internal vs. external validity Internal validity refers t whether the analysis is valid fr the ppulatin and sample being studied.