Transcript John Taylor, UNR Lecture, May 4, 2015 PowerPoint

The Federal Reserve –
Stabilizing and Destabilizing
Influences on the U.S. Economy
John B. Taylor
May 4, 2015
A Lecture Sponsored by
the UNR Economics Club and University of
Nevada Foundation
U.S. Inflation
Percent
12
12
4-quarter average
Inflation rate
10
10
8
8
6
6
4
4
2
2
0
0
55
60
65
70
75
80
85
90
95
00
05
10
2
Arthur Burns, Fed chair (1970-78) during the
Great Inflation, increased money supply rapidly ,
raising inflation, despite telling Congress
the Fed would not do it
Congressional
Testimony of
Arthur Burns
Five years later, inflation is roaring,
President goes to Congress with
“Whip Inflation Now” buttons.
President Ford speaks to
joint session of Congress
U.S. Inflation
Percent
12
10
12
4-quarter average
10
Inflation Rate
8
8
Q1 1968
Fed funds
rate = 4.8%
6
6
4
4
2
2
0
0
55
60
65
70
75
80
85
90
95
00
05
10
5
Finally Sensible Monetary Policy
U.S. Inflation
Percent
12
10
12
4-quarter average
Q2 1989
Fed funds
rate = 9.7%
Inflation Rate
10
8
8
Q1 1997
Fed funds
rate = 5.5%
Q1 1968
Fed funds
rate = 4.8%
6
6
4
4
2
2
0
0
55
60
65
70
75
80
85
90
95
00
05
10
U.S. Inflation
Percent
12
10
12
4-quarter average
Q2 1989
Fed funds
rate = 9.7%
Inflation Rate
10
Q3 2003
Fed funds
rate = 1.0%
8
Q1 1997
Fed funds
rate = 5.5%
Q1 1968
Fed funds
rate = 4.8%
6
8
6
4
4
2
2
0
0
55
60
65
70
75
80
85
90
95
00
05
10
Percent
20
Percent
15
10
5
0
-5
-10
-15
1950
1960
1970
1980
1990
Growth rate of real GDP
2000
2010
Billions of 2009 dollars
20,000
19,000
2.5%
18,000
17,000
16,000
15,000
-- 2014.1
Real GDP
14,000
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Not returning to growth path…
…as in past recoveries
12
Example from Bernanke (2004) updated to post 2006
.
(post-2006)
C
The Role of Monetary Policy
U.S. Inflation
Percent
12
10
12
4-quarter average
Q2 1989
Fed funds
rate = 9.7%
Inflation Rate
10
Q3 2003
Fed funds
rate = 1.0%
8
Q1 1997
Fed funds
rate = 5.5%
Q1 1968
Fed funds
rate = 4.8%
6
8
6
4
4
2
2
0
0
55
60
65
70
75
80
85
90
95
00
05
10
A more systematic way to look at policy
where
r is the federal funds rate
p is the inflation rate
y is real GDP gap
1965-1980: monetary policy not
well described by good rulesbased policy
1965-79
From “Has the Fed Gotten
Tougher on Inflation?” The
FRBSF Weekly Letter, March
31, 1995, by John P Judd and
Bharat Trehan of the San
Francisco Fed
r = p +.5y +.5(p-2) +2
Monetary policy gets more rulesFrom “Has the Fed Gotten
based
Tougher on Inflation?” The
1965-79
FRBSF Weekly Letter, March
31, 1995, by John P Judd and
Bharat Trehan of the San
Francisco Fed
1987-92
1993-94
Illustrative monetary policy chart from St Louis Fed
February 2007, Bill Poole (former president)
Illustrative monetary policy chart from St Louis Fed
February 2007, Bill Poole (former president)
Chart from The Economist, October 18, 2007
Housing Investment versus Deviations
from the Taylor Rule in Europe During 2001-6
Billions of dollars
3,000
QE3
2,500
2,000
QE2
1,500
QE1
1,000
500
Liquidity Operations
/
\
9/11
2008 Panic
Counterfactual without QE
0
2000 2002 2004 2006 2008 2010 2012 2014
Reserve Balances
22
Billions of dollars
3,000
QE3
2,500
2,000
QE2
1,500
QE1
1,000
500
Liquidity Operations
/
\
9/11
2008 Panic
Counterfactual without QE
0
2000 2002 2004 2006 2008 2010 2012 2014
Reserve Balances
23
Empirical Evaluation of QE
• Most favorable evidence comes from
announcement effects
– But these miss the reversal period
• My research shows little effect of QE1 MBS
once credit and prepayment risks were taken
into account
• QE3: When started 10-year Treasury was
1.7%, it then rose
• Effects of QE on yield spreads
– 1-year vs 10-year US Treasury spread
– 2003-2008 non-QE period……1.3%.
– 2009-2013 QE period……………2.4%
Forward guidance, in practice,
has also been unpredictable
– Dec 2008: “Exceptionally low levels…for “some
time…”
– Mar 2009: “…for an extended period…”
– Aug 2011: “…at least through mid-2013…”
– Jan 2012: “…late 2014…”
– Sep 2012: “…through mid-2015…”
– Dec 2012: “…at least as long as the
unemployment rate remains above 6 ½ percent…”
– Feb 2014: abandon unemployment threshold
Adverse effects of UMP
• Creates incentives for otherwise risk-averse
investors—retirees, pension funds—to take on
too much risk
• Excursion into fiscal policy and credit
allocation raises questions about central bank
independence
• Redistributive in an arbitrary way
• Distorts price discovery in markets
• Money markets do not function normally
• Uncertainty about unwinding creates 2-sided
risk
Rules–Based versus Discretionary Periods
• Statistical Classification: 1984-2002
• Nikolsko-Rzhevskyy, Papell, and Prodan (2014)
• Historical Classification : 1985-2003
• Meltzer (2009, 2011)
But Virtually No Change in
De Jure Independence
• Small legal changes in 1977, 2000, 2010
• Crowe and Meade (2007)
– Used standard indices of de jure central bank
independence
– Found no change over time for the US.
• “Federal Reserve de jure independence is far
too uncritically accepted as a foundation for a
stable financial and monetary environment.”
Cargill and O’Driscoll (2013).
Changes in De Facto Independence
• Meltzer A Monetary History of the Federal
Reserve
– 1970s e.g. Burns-Nixon
– 1980s-1990s e.g. Volcker (1983) “We have…gone a
long way toward changing the trends of the past
decade and more.”
– 2000s
• Involved in fiscal policy, credit policy, housing policy,…
• Can be driven by the executive branch or the central bank,
or both
• Goodfriend (2012) Issing (2012) come to similar
conclusions
International Effects
• Policy deviations spread to other countries
• OECD researchers found similar pattern for OECD
• Starting around 2003 policy rates too low
• BIS researchers found
• Global Great Deviation
Causes of Spillovers of Policy Deviations
• Central banks follow deviations with “below
policy rule” rates because of concerns about
– Excessive and uncertain exchange rate
appreciation
– Excessive risk-taking in foreign currency loans
• Groupthink about discretion versus rules
• Political pressures reducing de facto central
bank independence
Currency Wars Fought
with Monetary Instruments
• Conventional monetary policy
– Can be illustrated with a simple diagram.
• Unconventional monetary policy
– Seems to work much the same:
• Fed 2010
• BOJ 2012
• ECB 2014
2nd central
bank
i
1st central
bank
Initial cut is 1%
Δi = -2
Δif = -2
if
Source: Hyun Shin, BIS
Currency Wars Fought
with Monetary Instruments
• Conventional monetary policy
– Can be illustrated with a simple diagram.
• Unconventional monetary policy
– Seems to work much the same:
• Fed 2010
• BOJ 2012
• ECB 2014
Global Consequences
• Forces discretionary macro-prudential policy
– Singapore, Switzerland, Hong Kong
• Provides excuses for more capital controls
• Creates increased intervention in currency markets
• Undermines inflation targeting principles
– had led to less intervention, more rules-based policy
• Infects other parts of economic policy
• The end of
NICE (Non-Inflationary Consistently Expansionary)
• led to the end of another
NICE (Nearly International Cooperative Equilibrium)
What to Do
• Return to more rules-based monetary
policies similar to what worked during
the 1980s, 1990s and until recently
Can anything be done to help it along?
• In the United States, legislation may be needed
• In fact, some legislation is underway.
• "Requirements for Policy Rules for the Fed" in
bill recently passed by House Financial Services
Committee
• Requires that the Fed report publicly its rule or
strategy for the policy instruments
• The Fed, not Congress, would choose rule or
strategy.
But what about other central banks in
the globalized world economy?
• A clear commitment by the Fed would help
– whether aided by legislation or not
• An international understanding would help
further.
– Major central banks have a common inflation target
– Converging views about response of policy
instruments.
Would the approach be enough to provide
stability in markets and economies?
• Research (Helene Rey) finds that large capital
flows are induced by erratic swings in
monetary policy; these would diminish
• Large capital flows due to “fear of free falling”
exchange rates would be calmed too
– Research shows that adoption of rules-based
inflation targeting has had that effect already