Working Papers

Greenspan versus Taylor

Former Federal Reserve Chairman Alan Greenspan defends the Fed’s record against criticism from John Taylor:

However, starting in mid-2007, history began to be rewritten, in large part by my good friend and former colleague, Stanford University Professor John Taylor, with whom I have rarely disagreed. Yet writing in these pages last month, Mr. Taylor unequivocally claimed that had the Federal Reserve from 2003-2005 kept short-term interest rates at the levels implied by his “Taylor Rule,” “it would have prevented this housing boom and bust. “This notion has been cited and repeated so often that it has taken on the aura of conventional wisdom.

Aside from the inappropriate use of short-term rates to explain the value of long-term assets, his statistical indictment of Federal Reserve policy in the period 2003-2005 fails to address the aforementioned extraordinary structural developments in the global economy. His statistical analysis carries empirical relationships of earlier decades into the most recent period where they no longer apply.

Moreover, while I believe the “Taylor Rule” is a useful first approximation to the path of monetary policy, its parameters and predictions derive from model structures that have been consistently unable to anticipate the onset of recessions or financial crises. Counterfactuals from such flawed structures cannot form the sole basis for successful policy analysis or advice, with or without the benefit of hindsight.

Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have “prevented” the housing bubble. All things considered, I personally prefer Milton Friedman’s performance appraisal of the Federal Reserve. In evaluating the period of 1987 to 2005, he wrote on this page in early 2006: “There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind.”

Proving that great minds think alike, I will shortly be releasing a CIS policy monograph making much the same argument in the context of a broader discussion of the relationship between monetary policy and asset prices. I discussed the issue with John Taylor at the New York MPS meeting, but could not bring him around to my point of view.


posted on 11 March 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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The Greenspan Counter-Factual

Alan Greenspan on the counter-factual to the Fed’s 2001-2004 easing cycle:

“If we tried to suppress the expansion of the subprime market, do you think that would have gone over very well with the Congress?” Mr. Greenspan said. “When it looked as though we were dealing with a major increase in home ownership, which is of unquestioned value to this society — would we have been able to do that? I doubt it.”

Mr. Greenspan said that if he had taken steps to prevent the crisis, the outcome would have been painful.

“We could have basically clamped down on the American economy, generated a 10 percent unemployment rate,” he said. “And I will guarantee we would not have had a housing boom, a stock market boom or indeed a particularly good economy either.”

posted on 13 February 2009 by skirchner in Economics, Monetary Policy

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A $42 Billion Future Tax Increase: Immiseration Not Stimulation

I have an op-ed in The Australian, arguing that the government has just announced a $42 billion future tax increase.  In reality, it’s worse than that because of the interest bill on the $42 billion in unfunded spending, plus the future welfare costs associated with an increased tax burden and the government’s diversion of resources away from potentially more highly valued uses.  The package will immiserate rather than stimulate.

In the statement accompanying yesterday’s 100 basis point cut in the official cash rate, the Reserve Bank said that ‘the Board took into account the package of measures announced by the Government earlier today.’  If the RBA shares the Treasury’s Keynesian assumptions about the implications of the package for short-term economic growth, then it is entirely possible that yesterday’s rate cut was smaller than it might have been in the absence of the latest fiscal stimulus package.  While fiscal policy has been irrelevant to monetary policy in recent years due to a steady fiscal impulse, it is less likely the RBA will ignore the massive turnaround in the budget balance we have seen since May last year.  Those ‘free’ pink batts are likely to have come at the cost of a higher mortgage interest rate.

posted on 04 February 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy

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Monetary and Fiscal Policy Effectiveness in a Globalised World

Alan Greenspan, interviewed in Die Zeit, on the effectiveness of monetary and fiscal policy:

Global forces can now override most anything that monetary and fiscal policy can do. Long-term real interest rates have significantly more impact on the core of economic activity than the individual actions of nations. Central banks have increasingly lost their capacity to influence the longer end of the market. Two to three decades, ago central banks were dominant throughout the maturity schedule. Thus, the more important question is the direction of long-term real interest rates…

The resources of central banks relative to the size of global forces have markedly diminished. We have 100 trillion dollars of arbitragable long-term securities in the world today so that even large movements initiated by central banks have little impact. Until the seventies, central banks and finance ministries were able to hold exchange rates fairly stable. Since then, the ability to intervene in the exchange markets and stabilize the rates has gone down very dramatically. And that is also true for other financial markets. Global forces fostering global equilibrium have become by far the most dominant influence for financial and economic activity. Governments have ever less influence on how the world works.

The way it should be.


posted on 21 December 2008 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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One Speech, Two Stories

The Australian:

RESERVE Bank governor Glenn Stevens last night flagged further interest rate cuts to help shore up the economy.

The AFR:

Reserve Bank Governor Glenn Stevens has signalled the bank’s unprecedented series of deep interest rate cuts may have come to an end.

Both papers fell victim to the view that every time the Governor speaks, he must be sending a signal on interest rates and if there is no explicit signal, then there must be an implied one.  In fact, the RBA very rarely signals its policy intentions, not least because its view on the future direction of policy is not very strongly held.  Unlike the rest of us, the RBA doesn’t need to anticipate its own actions, putting more value on policy flexibility than policy predictability.

posted on 09 December 2008 by skirchner in Economics, Financial Markets, Monetary Policy

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