Updating prior beliefs

The New York Times has a piece discussing how two famous economists updated their beliefs on the efficacy of monetary policy in response to new information. First Narayana Kocherlakota:

“It’s a little embarrassing to say this, but you make a speech in August of 2010 and it inspires a whole quantity of work where people say, ‘This is what Kocherlakota says and we will now show in this paper that Kocherlakota was wrong,’ ” he said. “There’s a number of ways that people can react to that, and I reacted in the only way that a sensible person can, which is to update.”

In September 2012, shortly after the Fed announced a fresh expansion of its stimulus campaign, Mr. Kocherlakota returned to Michigan’s Upper Peninsula to announce that he had changed his mind. Contrary to his prediction, inflation was slowing. That meant the Fed had the opportunity and responsibility to do more.

Right now he’s the only one at the Fed arguing publicly that they should do more (according to the NYT.) That makes him my favorite government official.

Before discussing the second example in the NYT piece, a bit of background information.  Edward Prescott played a pivotal role in developing real business cycle theory in the late 1970s and early 1980s.  Prescott claimed that monetary shocks did not have significant effects on real output.  At about the same time both monetarist and Keynesian economists were arguing that if the Fed brought the rate of inflation down rapidly, unemployment would soar much higher in the short run.  The monetarists claimed unemployment would later fall back to the natural rate, even if inflation stayed low.  The Keynesians were less sure about that.

In 1981-82 the Volcker Fed did bring inflation down very sharply, and unemployment soared to 10.8%, the highest rate since 1940.  How did this event affect Prescott’s views?  This is from the same NYT column:

Edward C. Prescott, who won the Nobel in economic science in 2004 and is on the Minneapolis Fed’s research staff, said Mr. Kocherlakota was misjudging the Fed’s abilities. “It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed,” Professor Prescott, also on the faculty of Arizona State University, wrote in an email. Bond buying, he wrote, “is as effective in bringing prosperity as rain dancing is in bringing rain.”

Well that settles it.

Speaking of rain dancing, I used to think Kocherlakota was of Native American descent.  Not so:

Correction: January 27, 2014

An earlier version of this article misstated where Narayana Kocherlakota was raised. He was raised in Winnipeg, Manitoba, not Calgary, Alberta. It also misstated the age at which he received his doctorate. He was 23, not 24.

Because of an editing error, the article also misstated the origin of Mr. Kocherlakota’s name. His name is Indian, not American Indian.

HT:  Saturos, Michael Byrnes



36 Responses to “Updating prior beliefs”

  1. Gravatar of Vivian Darkbloom Vivian Darkbloom
    28. January 2014 at 12:07

    I guess if someone is courageous enough to change his or her mind we should at least allow them the dignity to call it an “update”.

  2. Gravatar of ssumner ssumner
    28. January 2014 at 12:14

    I agree.

  3. Gravatar of WC WC
    28. January 2014 at 13:05

    So Prescott still thinks that monetary shocks don’t cause changes in output/employment? Seriously?

  4. Gravatar of Edward Edward
    28. January 2014 at 13:10

    How can Ed Prescott call himself an economist even? I’m embarrassed to share his first name

  5. Gravatar of Nick Rowe Nick Rowe
    28. January 2014 at 14:08

    He’s definitely going up in my estimation. I have updated too.

  6. Gravatar of Greg Ransom Greg Ransom
    28. January 2014 at 14:27

    I notice that economists answer Prescott with gasps, laugher, ridicule, shame, etc. — but can’t definitively falsify his perspective — all you’ve got is attitudes about the disputed relationship of your own dubious, unpersuasive, ill-founded speculations to essentially contested evidence.

  7. Gravatar of ed ed
    28. January 2014 at 14:57

    Greg Ransom, it is Prescott who claimed something is “an established scientific fact,” so it seems the burden of proof is on him.

    I’m not a macro-economist, and I don’t have strong views on these issues, but from what I do know I’m inclined to trust the guy who is willing to update his views in light of evidence rather than the guy who claims his particular macro model has the status of established science.

  8. Gravatar of TravisV TravisV
    28. January 2014 at 14:58

    Global Market Liftoff!!!!!

    “The big news in markets this evening is the Turkish central bank decision.

    They raised rates MUCH more than expected in an attempt to stem the decline of the Turkish Lira.

    The shockingly big move is rippling across all global markets.

    Dow futures are surging.”


  9. Gravatar of J J
    28. January 2014 at 14:59

    Professor Sumner,

    If monetary policy has no real effect, then why is inflation so bad? For example, in a plain frictionless RBC model, monetary policy is irrelevant but inflation is also irrelevant. If economists want to claim that monetary policy doesn’t matter, then they shouldn’t really care one way or the other. I don’t understand why such economists are strongly opposed to doing more. Any thoughts?

  10. Gravatar of 123 123
    28. January 2014 at 15:14

    “Speaking of rain dancing, I used to think Kocherlakota was of Native American descent”

    It is in his name:
    “Narayana is the Vedic Supreme God (including his different avatars) in Hinduism, venerated as the Supreme Being in Vaishnavism. He is also known as Vishnu and Hari”

  11. Gravatar of John Becker John Becker
    28. January 2014 at 15:30


    If you believe that money is neutral in the long run, aren’t you forced to believe Prescott’s statement?

  12. Gravatar of Doug M Doug M
    28. January 2014 at 16:06

    When I first few times I hear the name thought people were calling him “Coach Lakota.” I couldn’t figure out who he used to coach that the world called him Coach.

    Once I found out his name was Narayana, I jumped to eastern Indian, but that is perhaps because I went to school with a Narayana

  13. Gravatar of Saturos Saturos
    28. January 2014 at 16:31

    123, not to nitpick but the Vedas themselves didn’t really have a supreme god, it was more like Norse myth where Indra played the Odin role. Narayana preserves the universe along with with the rest of the Hindu trinity, Brahma the Creator (not to be worshipped) and Shiva the Destroyer, and worshipping him above other deities is what defines Vaishnavism. We should probably glad that “Shiva” Kocherlakota did not get on to the Fed! (oh wait Plosser.)

    Kocherlakota is a Telugu name from the Andhra Pradesh region, one of the more developed parts of India these days.

  14. Gravatar of Tom Brown Tom Brown
    28. January 2014 at 16:49

    Mark A. Sadowski, re: Prescott & Kydland & RBC: The following have to be my favorite quotes from you that you left on Nick Rowe’s blog on this subject:

    “I’ve wagered my whole economic life on the defeat of RBC.”


    “Kydland and Prescott’s work is a tough sell to me. You don’t seem to get it. As far as I’m concerned they are the dark side. I’ll combat with every ounce of energy I have into the darkest corners of hell.”


  15. Gravatar of Tom Brown Tom Brown
    28. January 2014 at 16:55

    … and given your usual level of enthusiasm, skill & perseverance I’d really hate to have a Sadowski sentiment like that directed at me! (I only brought that up because I see that Prescott & RBC have come up in a number of comments here, and in Scott’s post too: I’m assuming that’s the same Prescott & the same RBC).

  16. Gravatar of Tom Brown Tom Brown
    28. January 2014 at 16:59

    … and BTW, if your average Joe made a comment like that, I’d write it off to egotistical bluster, and perhaps alcohol or drug use (bath salts?)… but in your case, I’m inclined to take it seriously!

  17. Gravatar of ssumner ssumner
    28. January 2014 at 18:09

    Nick, I agree.

    Greg, I thought you were an Austrian. Have you switched to RBC?

    And no, I wasn’t laughing at his views on money neutrality, just the way he expressed his views. Most normal people would have been amused by his comment, even if they agreed with his views on money neutrality. Most Austrians would view his comment as being absurd.

    J, I suppose he’d argue that high inflation raises the tax on capital. But that raises the question of why it doesn’t have real implications. Presumably he means no demand-side effects.

    John Becker, ??????? You’ll have to explain that one to me, as it went right over my head.

    Everyone, Prescott is a fine economist. But like many fine economists he’s not a good monetary economist. Indeed like almost all fine economists . . .

  18. Gravatar of Michael Byrnes Michael Byrnes
    28. January 2014 at 18:31

    I wonder how close Kocherlakota is to supporting NGDPLT?

    He has recently started citing Paul Volcker. He even named a recent speech “A Time of Testing”… after a 1979 Volcker speech.

    He’s probably familiar with another prominent macroeconomist who has talked about “regime change” and “Volcker moments”.

    And of course the parallel between today and 1979 is more obvious to an NGDPLT advocate (or someone who leans in that direction) than it would be to an RBC/inflationphobe.

  19. Gravatar of Major_Freedom Major_Freedom
    28. January 2014 at 18:35

    Volcker brought down inflation only temporarily. Soon after the early 1980s “experiment”, he vastly inflated and blew up a bubble that culminated, in part, in the 1987 stock market crash.

  20. Gravatar of Tom Brown Tom Brown
    28. January 2014 at 18:36

    Scott, re: Prescott: knowing zip about Prescott’s work I’ll take your word for it… but I’d still love to hear what inspired Sadowski’s strong statements.

    “…he’s not a good monetary economist.”

    Would you put Woodford in that category as well?

  21. Gravatar of Tom Brown Tom Brown
    28. January 2014 at 18:42

    … and yes, I do squirrel away my favorite quotes from all you blog people: like a crow bringing shiny objects back to the nest, I may not understand what they mean or why they’re important, but I’ll save a link to it so I can find it again some day. :D

  22. Gravatar of John Becker John Becker
    28. January 2014 at 19:33


    If you believe that money is neutral in the long run and the Fed controls money, then by extension, what the Fed does is neutral in the long run just like Prescott says in the quote. As you’ve said before, whether the Fed runs 2% inflation per year or 0% inflation per year doesn’t have that big of an impact on output or employment over a long period of time. You’ve said this numerous time so I don’t get why you want to pick a fight with Prescott for saying basically the same type of thing.

    I personally think that price inflation and the Fed reduce real incomes from what they would have been if the Fed never existed. The fact that they caused the Great Depression doesn’t help their case for not making an impact either.

  23. Gravatar of Mark A. Sadowski Mark A. Sadowski
    28. January 2014 at 21:00

    Tom Brown,
    The most interesting thing about that comment thread that you dug up is that I don’t remember Philip Pilkington being part of that conversation. I’ve recently conversed with him at his own blog and in my opinion that didn’t go so well for him. (He honestly didn’t know that Spain did a [monumentally huge] fiscal stimulus in 2008-10.) In fact, it’s interesting in general the degree to which the wheels have seem to come off the whole fiscalist/endogenous money enterprise in the last couple of years.

    Yes, I still detest RBC and I don’t care much for Prescott’s research. (I have fewer problems with Kydland.) However, I’ve become much more disciplined in my commenting since then, and consequently provide far fewer such juicy quotes. (Instead I usually just go for the jugular, and then call it a day.)

    RBC has been declared prematurely dead, and by virtue of its pervasive influence at high levels within academia and the Fed, is probably a far more dangerous influence than any other school of economic quackery. At research seminars you can still find really smart Fed economists trying to do really stupid things like (for example) simulate asset price bubbles with technology/productivity shocks. (Another case in point: Stephen Williamson.) You would think after having the biggest demand side meltdown the economy’s seen in 80 years such people wouldn’t dare to trot out such crap in public anymore for fear of ridicule, but it’s like everybody’s afraid to point out that the emperor has no clothes. And this especially applies to Edward Prescott, whose whole life’s work (in my opinion) is just a long series of glorified horse manure piles (pick any paper at random).

    And you can quote me on that.

  24. Gravatar of Saturos Saturos
    29. January 2014 at 01:25

    John Becker, “money is neutral in the long run” is very different from “the Fed has had no effect on real output since its formation”… the scientific consensus, as Krugman highlights, is exactly the opposite.

  25. Gravatar of J.V. Dubois J.V. Dubois
    29. January 2014 at 01:57

    I already had huge respect for Narayana Kocherlakota but this article even increased it. It takes a lot of courage to change views in his circumstances.

    Also that Prescott claim … I am speechless. First, because if it is true that means that Friedman and Schwartz have to be wrong about great depression and as Scott mentioned also Volcker disinflation did “nothing”.

    Second if FED does not matter why is Prescott even commenting on monetary policy? He should be indifferent about FED producing 20% deflation or even Zimbabwe like inflation, right? Or is there some catch? Then why use such a strong words as “scientifically established fact”.

    PS: Scott good catch on Greg. All Austrians say is how inflation messes up price signals and how it changes structure of production and all that. This seems as a very real impact of FED.

  26. Gravatar of Saturos Saturos
    29. January 2014 at 01:58

    Off topic – does anyone else think Australian monetary policy is running a bit too tight right now? Scott?

  27. Gravatar of W. Peden W. Peden
    29. January 2014 at 06:50

    Greg Ransom,

    You don’t have to “definitvely falsify” someone’s claim in order to criticise it. Many things are consistent with the evidence, which is not to say that they aren’t also very improbable given the evidence.

  28. Gravatar of W. Peden W. Peden
    29. January 2014 at 06:51

    And yes: Narayana Kocherlakota deserves a lot of credit for his demonstration of good scientific reasoning. It’s not true that we need more economists or scientists like him- need more PEOPLE like him, regardless of what they do.

  29. Gravatar of EB EB
    29. January 2014 at 07:18


    Have you seen the emails the NYT journalist and Prescott exchanged? Can you relate Prescott’s answer as reported by the NYT journalist to anything he ever published on monetary policy? (please give references).

  30. Gravatar of Tom Brown Tom Brown
    29. January 2014 at 10:38

    “And this especially applies to Edward Prescott, whose whole life’s work (in my opinion) is just a long series of glorified horse manure piles (pick any paper at random).

    And you can quote me on that.”

    Done! I’ve already squirreled that shinny… uh, turd, away for future reference, and I promise to try to use that one in place of your less disciplined quotes from the past. :D

  31. Gravatar of ssumner ssumner
    29. January 2014 at 12:25

    Michael, It would be nice if he endorsed NGDPLT.

    Tom, Woodford is not a good monetary economist, he’s a great monetary economist.

    John, You misinterpreted that quotation. He’s saying no effect in the short run.

    Saturos, You would know better than me. What’s the NGDP growth forecast for 2014? Around 5%?

    EB, No, I haven’t seen the emails, and I can’t imagine why I would care. If you set them on the desk in front of me I would not be interested in reading them.

  32. Gravatar of Tom Brown Tom Brown
    29. January 2014 at 13:44

    Scott, re: Woodford. Good to know. That clears up your previous statement for me.

  33. Gravatar of Mark A. Sadowski Mark A. Sadowski
    29. January 2014 at 16:14

    For what it is worth, in my opinion the following paper goes further in explicitly estimating the proportion of variation in real output attributable to monetary policy than any other:

    What are the effects of monetary policy on output? Results from an agnostic identification procedure
    By Harald Uhlig

    “This paper proposes to estimate the effects of monetary policy shocks by a new agnostic method, imposing sign restrictions on the impulse responses of prices, nonborrowed reserves and the federal funds rate in response to a monetary policy shock. No restrictions are imposed on the response of real GDP to answer the key question in the title. I find that ‘‘contractionary’’ monetary policy shocks have no clear effect on real GDP, even though prices move only gradually in response to a monetary policy shock. Neutrality of monetary policy shocks is not inconsistent with the data.”


    Uhlig notes in a footnote on the first page his gratitude to Chris Sims and a long list of other economists (including Bernanke) for their helpful discussions and comments.

    On page 384 Uhlig notes:

    “‘‘Contractionary’’ monetary policy shocks have an ambiguous effect on real GDP. With 2/3 probability, a typical shock will move real GDP by up to +/- 0.2 percent, consistent with the conventional view, but also consistent with e.g. monetary neutrality. Indeed, the usual label ‘‘contractionary’’ may thus be misleading, if output is moved up. Monetary policy shocks account for probably less than 25% of the variance for the 1-year or more ahead forecast revision of real output, and may easily account for less than 2% at any given horizon.”

    On page 392 he states:

    “I have followed the empirical approach in Bernanke and Mihov (1998a, b), who have used real GDP, the GDP deflator, a commodity price index, total reserves, nonborrowed reserves and the federal funds rate for the U.S. at monthly frequencies from January 1965 to December 1996.

    He explains his results in greater detail on page 398-399:

    “According to the median estimates, shown as the middle lines in this figure, monetary policy shocks account for 5 10% of the variations in real GDP at all horizons, for up to 20% of the long-horizon variations in prices and 15% of the variation in interest rates at the short horizon, falling off after that. Explaining just two or so percent of the real GDP variations at any horizon is within the 64% error band: it thus seems fairly likely, that monetary policy has practically no effect on real GDP. This may either be due to monetary policy shocks having little real effect, or due to a Federal Reserve Bank keeping a steady hand on the wheel, as argued by Cochrane (1994), Woodford (1994) or Bernanke (1996).”

    Examination of the graph on page 400 reveals that the peak proportion of variation in real GDP attributable to monetary policy shocks occurs at the 2 month horizon. It also reveals that 16% of the time the proportion of variation is greater than 40% at the 2 month horizon. In a 32 year period that would mean that would have occurred in approximately 61 months.

  34. Gravatar of Full Employment Hawk Full Employment Hawk
    30. January 2014 at 21:00

    “Edward C. Prescott … is on the Minneapolis Fed’s research staff” What is a person who believes that monetary policy has virtually no effect on output doing on the research staff of a central bank that has a congressional mandate to seek maximum employment?

  35. Gravatar of ssumner ssumner
    31. January 2014 at 15:31

    Mark, Back when I followed that literature I was never convinced that they had solved the identification problem. What do you think? Suppose NGDP shocks were treated as monetary shocks. And allowed to impact RGDP in the current period. How would that change things?

  36. Gravatar of Mark A. Sadowski Mark A. Sadowski
    31. January 2014 at 16:53

    Well if all NGDP shocks were treated as monetary shocks then we’re assuming that AD shocks are purely monetary in origin. Obviously that would result in much larger estimates for the proportion of RGDP variation attributable to monetary policy shocks.

    That also seems like too strong an assumption to me. That is, I think that it is implicit that monetary policy is ultimately responsible for the level of NGDP at any point in time, but that doesn’t necessarily mean monetary policy is solely responsible for every shock to AD.

    Interestingly, I posted the same comment at Steve Williamson’s blog and naturally he and others criticized that paper for greatly overestimating the amount of RGDP variation due to monetary policy shocks.

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