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Monday, April 16, 2012

New Model Validation of Stimulus Impacts

A paper just published in the American Economic Journal: Macroeconomics sheds additional light on the Keynesian multiplier debate, which has surged since the 2009 stimulus package—ARRA—was enacted. In January 2009 Christina Romer and Jared Bernstein released a widely-cited paper showing that the multiplier for ARRA would be quite large. In February 2009, John Cogan, Tobias Cwik, Volcker Wieland and I (CCTW) released a paper showing that more modern “New Keynesian” models implied a much smaller multiplier. Since then many papers have been written including a paper by Christiano, Eichenbaum and Rebelo which found larger multipliers in the Christiano, Eichenbaum, and Evans (CEE) New Keynesian model. The debate has focused on the size of the government purchases multiplier.

The new paper, Effects of Fiscal Stimulus in Structural Models, is written by 17 authors from central banks and international institutions around the world (Guenter Coenen, Chris Erceg, Charles Freedman, Davide Furceri, Michael Kumhof, René Lalonde, Douglas Laxton, Jesper Lindé, Annabelle Mourougane, Dirk Muir, Susanna Mursula, Carlos de Resende, John Roberts, Werner Roeger, Stephen Snudden, Mathias Trabandt, and Jan in’t Veld). As part of the research reported in the paper the authors compare the CCTW and the CEE estimates of ARRA with four estimated "New Keynesian" structural models of the kind used in practice by policymakers and their staffs. The other four models are:

        Bank of Canada’s GEM model (BOC)
        Fed’s FRBUS model (FRB)
        Fed’s SIGMA model (SIGMA)
        International Monetary Fund’s GIMF model (IMF)

Coenen and his colleagues simulated all 6 models in order to contrast and compare the impact of ARRA (using same time profile of government purchases first used by CCTW). The results for GDP are shown in the following three graphs (which correspond to Figure 7 of Coenen et. al. and refer to the US with three different levels of monetary accommodation). Observe that the four policy models confirm or validate the original CCTW estimates in the sense that they cluster around CCTW. In the case of the two year monetary accommodation the CEE model is a large outlier.

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.