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Friday, April 13, 2012

References to Policy Rules in a Speech by the Fed Vice Chair

In a speech to the Money Marketeers in New York City this past week, Fed Vice Chair Janet Yellen gave a useful description of how she and other policy makers are thinking analytically about monetary policy. The speech referred extensively to monetary policy rules, and I hope it generates more discussion of policy rules and strategies both within and outside the Fed. I have argued the the Fed has moved too far in a discretionary direction, and if it is going to move back to a rules-based policy, this is the kind of discussion that has to take place.

At this point I would only comment on two issues, both related to references to the Taylor rule in the speech.

First, the speech indicates that I proposed two different policy rules for the federal funds rate, one in a paper published in 1993 and the other published in 1999. As Janet Yellen puts it, “John Taylor has proposed two simple and well-known policy rules.” She then goes on to consider what she refers to as the Taylor (1993) rule and the Taylor (1999) rule. However, I did not propose or advocate another rule in 1999, as I emphasized after similar statements were made at a Senate Banking Committee hearing with Ben Bernanke in March of last year.

In the 1999 paper which Janet Yellen refers to, I did examine two rules: one which I described as the “policy rule I suggested” and another which I said “others have suggested.” The “others” were people at the Fed, and I did not propose this other rule. It is important to correct the record because the “others have suggested” rule has a much larger coefficient on the GDP gap and is therefore more likely to generate zero interest rates now and be used to rationalize quantitative easing.

Second, in the graphs contained in the speech Janet Yellen has the Taylor rule showing zero or below now and for quite a while longer. But if you assume inflation of 2 percent, the Taylor rule implies that the funds rate should be 1 percent even if you assume an output gap of negative 6 percent.  (1 = 1.5X2 + .5X(-6) + 1). The implied rate is higher for a smaller gap of 4 percent.