Comments on Taylor and Cochrane

Like John Cochrane, I’m feeling “grumpy” this morning.  Here’s John Taylor:

And in a new research paper, Scott Sumner suggests another way that Fed policy makers might conduct policy in which the monetary base or the interest rate is determined in an iterative manner based on nominal GDP futures without mentioning a reaction coefficient. In all these cases, the comparison with the Taylor Rule is less straightforward.

This confuses me on two levels.  First, it’s a Svenssonian “target the forecast” policy, so I don’t see how a direct comparison with the (backward-looking) Taylor Rule is possible.  And second, I’m confused because I did offer three very specific well spelled-out policy rules, and one discretionary rule.  Here’s one example of a specific reaction function from the paper:

For instance, each $1 purchase of a long position in an NGDP futures contract might trigger a $1,000 open-market sale by the Fed. A purchase of a $1 short position would trigger a $1,000 open-market purchase by the Fed. In that case, investors would be effectively determining the size of the monetary base.

Later in the post, Taylor cites a criticism of NGDP targeting by Robert Hall:

In his paper at the recent Jackson Hole conference, Bob Hall criticized nominal GDP targeting, citing his 1994 paper with Greg Mankiw. Bob argues that “A policy of stabilizing nominal GDP growth would require contractionary policies to lower inflation when productivity growth is unusually high. Such a policy might easily trigger a spell at the zero lower bound.” No one at the conference objected to this statement, and I do not recall nominal GDP targeting being mentioned at the conference, though policy rules were mentioned quite a bit.

No one objected to that statement because I’m never invited!!  Seriously, that statement seems flat out wrong, although I’m willing to change my mind if I’ve made a mistake somewhere.  To begin with, Hall should say inflation is low when output growth is high, not productivity.  Yes, they are correlated, but output is more accurate.  Much more importantly, interest rates would probably be almost unaffected by a change in inflation, and might even move inversely to inflation under NGDP targeting.  That’s because a rise in real growth would raise real interest rates by more than a fall in inflation would lower real rates.

Consider interest rates in recent decades, when inflation has been fairly stable at around 2%.  I think it’s fair to say that swings in interest rates (up to 6.5%, down to 1%, up to 5.5% down to 0%), have been driven almost entirely by swings in real growth, not expected inflation.  Notice that the swings in interest rates are comparable to the movement in real output over the business cycle.  And recall that rates would have fallen even further in 2009 had we not hit the zero bound. If we go back to the previous recession in 2001, nominal rates fell by more than RGDP growth declined.

Thus under NGDP targeting nominal rates would probably be much more stable than under inflation targeting.  No one questioned Hall at Jackson Hole?  Wow, we have our work cut out for us!

On the positive note Taylor cites an excellent paper on NGDP targeting by Evan Koenig:

In all these cases, the comparison with the Taylor Rule is less straightforward. Evan Koenig’s nice All in the Family paper also delves into the relationship between nominal GDP targeting and the Taylor Rule.

And in this paper Koenig shows how NGDP targeting helps to stabilize credit markets.  I should note that Koenig’s version of NGDPLT is different from the version I’ve proposed, as it relies on estimates of output gaps.  But it’s still far better than current policy, and (as I’ve discussed elsewhere) more politically feasible.

I’m so grumpy that I’m not letting Cochrane off Scott-free today.  Saturos asked me to comment on John Cochrane’s interpretation of the Phillips curve in recent history:

By the way, I think when the dust has settled, history will be kind to Ben Bernanke. He fits most of my job description. Inflation is stuck at 2%, the world did not melt down, and we’re all gradually coming to the realization that if $2 trillion bucks of stimulus and zero interest rates didn’t bring our economy out of the doldrums, there really is nothing more that a central bank could do. The Phillips curve has been screaming “this is supply, not demand” for a few years now.

And here’s how I responded to Saturos:

I’d say the PC has been screaming demand not supply, as have the asset markets. In 2009 we had deflation, the biggest drop in NGDP since 1938 and soaring unemployment. How is that not demand? Since then we’ve had the slowest recovery in demand in any expansion in US history (at least as far back as I know), and a slow recovery in RGDP. What’s the mystery here that needs to be explained?

I’d add that if Milton Friedman heard that University of Chicago economists were propounding “liquidity trap” theories he’d be rolling over in his grave. Especially if they were efficient markets-types and the markets were screaming that QE is effective.  Not to mention Japan, where 2013:Q2 growth was just revised up to 3.6% and the yen has plunged and stocks have soared on policies that an unholy alliance on the left and right thinks are meaningless.

PS.  Just to be clear, bad supply-side policies have slowed the recovery.  Casey Mulligan has some good points.  But the main problem has clearly been demand.

PPS.  Commenter Blue Aurora has sent me information on a new film coming out soon on the Fed.  This link has a trailer.

HT:  123



32 Responses to “Comments on Taylor and Cochrane”

  1. Gravatar of Blue Aurora Blue Aurora
    9. September 2013 at 08:38

    Thanks for acknowledging me, Professor Scott B. Sumner…I feel somewhat honoured! Hopefully you’ll see the documentary sooner or later, with perhaps some pressure from your undergraduate students and colleagues in the Economics Department at Bentley University, right? 😛

  2. Gravatar of ssumner ssumner
    9. September 2013 at 08:56

    It depends how much pressure I get!

  3. Gravatar of Roger Sparks Roger Sparks
    9. September 2013 at 09:13

    I frequently see logical arguments based on how interest rates are expected to change as a result of the action discussed. This always bothers me because the Federal Reserve is using interest rates as a tool. Interest rates as-a-tool is directly opposite interest rates as-a-reaction-to-events.

    Lower interest rates as-a-tool is intended to increase transactions, thus increasing NGDP. The Fed seems to forget that a large demographic of people depend upon HIGHER interest rates for present consumption. This demographic reacts to low interest rates by REDUCING consumption, thus lowering NGDP. Success in Fed policy, therefore, depends upon overcoming this NGDP-negative force with even stronger inflationary money supply expansion force. So far, the “don’t fight the Fed” response seems to be working best.

  4. Gravatar of Saturos Saturos
    9. September 2013 at 09:18

    Blue Aurora, what are some of the ideas in the film?

  5. Gravatar of 123 123
    9. September 2013 at 09:32

    Here is a related comment by Andy Harless:

  6. Gravatar of John Taylor & Bob Hall get it backward | Historinhas John Taylor & Bob Hall get it backward | Historinhas
    9. September 2013 at 09:48

    […] I see John Taylor made Scott feel […]

  7. Gravatar of Michael Michael
    9. September 2013 at 09:54

    “”A policy of stabilizing nominal GDP growth would require contractionary policies to lower inflation when productivity growth is unusually high. Such a policy might easily trigger a spell at the zero lower bound.””

    It’s funny how people come up with complicated ways to explain a less complicated concept.

    Reading this argument from Hall, I picture the FOMC huddled around a new toy: the “Productivity-O-Meter”. When they see productivity falling, they know to raise their infation target in order to maintain the NGDP trend path.

  8. Gravatar of Tommy Dorsett Tommy Dorsett
    9. September 2013 at 09:57

    The trailer features a lot of Fed critics, both those who want the Fed to have done more and those who want the Fed to do less and some who prefer no Fed at all. I’m really not sure how that hodgepodge advances the ball, frankly, especially with the parade of “I called the crisis!” self-congratulatory back slappers who usually called several crises before the one they “really” called struck. Not impressed.

  9. Gravatar of Becky Hargrove Becky Hargrove
    9. September 2013 at 10:20

    Marcus takes issue with Robert Hall’s quote:

  10. Gravatar of TallDave TallDave
    9. September 2013 at 10:57

    “A policy of stabilizing nominal GDP growth would require contractionary policies to lower inflation when productivity growth is unusually high. Such a policy might easily trigger a spell at the zero lower bound.

    Objection! Contractionary short-run monetary policy means higher nominal rates, and faster productivity growth should also imply higher nominal rates.

    I’m tempted to once again throw out that Milton Friedman quote about the long-term decline in interest rates under tight monetary policy.

  11. Gravatar of Aidan Aidan
    9. September 2013 at 11:04

    Speaking of Japan, I never thought I’d see the day when Paul Krugman argues against a tax increase that Scott Sumner supports:

  12. Gravatar of ssumner ssumner
    9. September 2013 at 11:39

    Roger, Yes, interest rates are a bad tool.

    123, Isn’t he forgetting that we favor targeting the forecast?

    Tommy, Yes, the trailer makes the film look bad. BTW, I just saw a GREAT film—“20 Feet from Stardom”

    Michael and TallDave, I’m puzzled too.

    Aidan, I very, very, very reluctantly support. It probably will hurt the economy in the short run.

  13. Gravatar of benjamin cole benjamin cole
    9. September 2013 at 11:43

    Social norms define much of economics.

    As seen in this blog, 40 years ago the Fed was growth-oriented to the point of ignoring inflation. We got low double digit inflation—and a 20 percent increase in real GDP in the last four years of the 1970s. Economists talked of “optimal output.”

    The social norm on the right today is that any inflation is bad and any stimulus by the Fed is bad. Fancy papers and blogging follow from these norms.

    BTW Cochrane is inconsistent. He says Bernanke has done a good job but in other posts has said QE is inert. Cochrane also says inflation id at 2 percent but it is running now at half that.

    All in all Cochrane is bringing very very little to the party.

  14. Gravatar of ChargerCarl ChargerCarl
    9. September 2013 at 12:18

    Oh man that Plosser quote from that trailer, so infuriating…

  15. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    9. September 2013 at 12:20

    ‘I’m not letting Cochrane off Scott-free today.’

    Good one!

  16. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    9. September 2013 at 12:25

    Speaking of efficient markets;

    ‘Credit rating agencies didn’t anticipate the Eurozone Crisis and their ratings have been procyclical ever since. …. Since 2009, credit ratings have persistently lagged behind market spreads, suggesting that ratings have been more lenient with respect to Eurozone countries than generally believed.’

    I noticed that Brooksley Born seems to be one of the anointed in this move about the Fed. I wonder what her explanation of the better performance of derivatives would be.

  17. Gravatar of 123 123
    9. September 2013 at 12:53

    Scott, I think Andy was talking about the coefficients of forward-looking Taylor rule.

  18. Gravatar of ssumner ssumner
    9. September 2013 at 13:10

    123, Sorry, I probably read it too fast.

  19. Gravatar of 123 123
    9. September 2013 at 13:53

    Scott, no, the comment was ambiguous. But I also found a place where Andy is 100% explicit:

  20. Gravatar of TESC TESC
    9. September 2013 at 15:42

    “policies that an unholy alliance on the left and right thinks are meaningless.”

    Dr. Sumners could you please expand or send a link where this situation in Japan between the left and the right is explained. I have no expertise on Japan’s politics (US, Mexico, and Spain have me very busy). It sounds interesting but I do not know where to start.

    In another note, Conchrane touched upon something I had in mind, inflation has been on target, the average CPI has been just above 2% from say 2004:
    2004-01-01 2.7
    2005-01-01 3.4
    2006-01-01 3.2
    2007-01-01 2.9
    2008-01-01 3.8
    2009-01-01 -0.3
    2010-01-01 1.6
    2011-01-01 3.1
    2012-01-01 2.1

    The FED has reach its goals. The lower average from 2009 until now has just been the averaging down of past years where it went above. Our only criticism could be that NGDP is a better target or that CPI is not really appropiate for the double mandate as you have said before.CPI does not include the price of new houses or even worse, it clculates housing with respect to a rigid rent pricing. But with respect to its goal of long term 2% CPI per annum, the FED has been right on target. Am I missing something?

  21. Gravatar of Geoff Geoff
    9. September 2013 at 15:49

    “For instance, each $1 purchase of a long position in an NGDP futures contract might trigger a $1,000 open-market sale by the Fed. A purchase of a $1 short position would trigger a $1,000 open-market purchase by the Fed. In that case, investors would be effectively determining the size of the monetary base.”

    The only reason why an investor would want to purchase an “NGDP futures” is to earn a return. What return is there on one of these contracts? The interest paid on margin, according to Dr. Sumner.

    The demand and hence price of NGDP futures contracts will have ZERO to do with NGDP, expected NGDP, or anything related to NGDP.

  22. Gravatar of George Selgin George Selgin
    9. September 2013 at 16:16

    “”A policy of stabilizing nominal GDP growth would require contractionary policies to lower inflation when productivity growth is unusually high.”

    Everyone else is picking on this, so why shouldn’t I? Taylor and Hall really deserve an F- for thinking that under NGDP growth targeting a “contractionary policy” is what lowers inflation as productivity growth increases, when in fact it is the simply fact of greater productivity itself that reduces inflation when no monetary action is taken to prevent it from doing so.

    It is almost painful for me to observe how such monetary policy giants can be so completely muddled in their thinking about such basic matters. But such is the state of affairs that comes from failing to appreciate the difference between prices (or the rate of inflation) declining because goods are becoming more abundant and prices or inflation declining because total spending is shrinking or is growing less rapidly than it had been.

  23. Gravatar of TESC TESC
    9. September 2013 at 17:22

    Dr. Selgin, while I was reading Dr. Taylor’s comments I was thinking “What would Dr. Selgin think about such a nonsense?”. I actually did not want to comment on it because I think it is too embarrassing on their part.

    About the fact that they are monetary theory giants, I have found it easier to teach NGDP targeting to high-schoolers and lay people then to knowledgeable individuals. Sadly economic circles, professionals and non-professionals, have such strong preconceptions/prejudices that any new point of view becomes an attack on their world view, not just an appeal to expand their economic analysis. That is probably why I find the NGDP targeting circles more intellectually attractive, there is room for meaningful exchange.

  24. Gravatar of Blue Aurora Blue Aurora
    9. September 2013 at 19:30

    Saturos: Did you visit the official website?

    Tommy Dorsett and Scott Sumner: Although the trailer for the film does feature clips with a lot of people who are critical of the Federal Reserve, and people who seem to be self-congratulatory for “seeing the financial crisis coming”, it does interview a broad range of perspectives. Allan Meltzer, Janet Yellen, Raghuram Rajan, Michael Bordo, Marvin Goodfriend, Alan Blinder, Paul Volcker, David Colander, Jeremy Grantham, Barry Ritholtz, and William White are among the personalities interviewed in the film. (This can be gathered from the cast of the official website.) I’m hoping that this film isn’t going to turn out to be garbage, but the fact it seems to be a serious effort and not the ideological echo chamber of an anti-Fed conspiracy theorist might be a sign it is worth seeing.

  25. Gravatar of lxdr1f7 lxdr1f7
    10. September 2013 at 01:35

    “Inflation is stuck at 2%”

    Could that be because of high private sector indebtedness and its accompanying interest costs?

  26. Gravatar of Shaun Shaun
    10. September 2013 at 05:13

    If John Taylor disagrees with you then you’re probably on to something and he feels threatened.

  27. Gravatar of ssumner ssumner
    10. September 2013 at 08:26

    123, Yes, That’s a very good post. But notice that there is a big difference between targeting the Taylor Rule using interest rates and targeting it using NGDP futures. To begin with, there is no zero bound problem with NGDP futures. So when people describe an NGDP policy in terms of a path for interest rates, they are not describing the market monetarist proposal. (This comment is directed at Andolfatto, not Harless.)

    TESC, I was merely refering to the fact that lots of people on both the left and the right think monetary policy is ineffective at the zero bound. Cochrane, Summers, and 50% of the time Krugman.

    The Fed does not target the CPI, they target the PCE. But in any case it does no good to hit a price level target on average. It’s like saying people cannot drown in a lake that averages 3 feet in depth. Inflation should be lower than average during boom periods and higher than average during recessions. But the Fed has done the reverse.

    There is another problem with your comment. You talk as if they Fed is an inflation targeter. Not true, they have a dual mandate and have been instructed to put equal weight on both sides. That’s one reason why an NGDP target is better.

    George, Hall must know this. I’d guess he had something else in mind, but I’m not sure what.

    Blue, Let’s hope so.

  28. Gravatar of e e
    11. September 2013 at 04:37


    These questions of what happens if NGDP growth is naturally above 5% seem a little silly in the current environment but i think theyre worth some thought.

    If we have productivity growth driving real GDP growth over 5% then a NGDPLT regime would produce price deflation but maybe not wage deflation, is that your answer? if it did produce wage deflation that would still be a problem that could produce unemployment right? Either way it seems like such an optimistic scenario that its hard to imagine getting hung up on.

    On the other hand if we had NGDP growth over 5% driven by population growth then i think a level targeting regime would produce wage deflation. My instincts are that you’d get something like late 19th century America with deep recessions and sharp recoveries. Certainly a pretty good time for people in this country but it still had a lot of wasteful mass unemployment.

    Am I off base on this? I hope so since mass immigration is so desirable for other reasons and one feature of mass immigration that I liked is that it virtually assured an increasing expected demand, making it both a supply and demand side improvement.

  29. Gravatar of PJ PJ
    11. September 2013 at 12:01

    If the only substantial criticism of NGDP targeting is the possibility of hitting the zero lower bound during an economic boom, then I’m all for it. I can’t fathom how that would be a problem even in the vanishingly small chance that it would actually happen.

  30. Gravatar of e e
    11. September 2013 at 15:45

    I’m all for it too PJ. I dont think the chances are vanishingly small though. I think its actually likely in emerging markets or in the US under Scott’s preferred immigration policy. NGDPLT is still better than what we have, but I’m curious what Scott thinks about these scenarios.

  31. Gravatar of ssumner ssumner
    12. September 2013 at 06:18

    e, Yes, wage deflation is the key problem to avoid, which is why you actually want to target NGDP/person, or nominal wages.

  32. Gravatar of PJ PJ
    12. September 2013 at 10:04

    e – I see your point about population growth, but like Sumner, I assume NGDPLT is done on a per capita basis or at least adjusted for large population swings.

    I associate economic expansion (periods of fast productivity growth) with high real interest rates because the marginal product of capital is relatively high. Since the end of the Great Inflation, the ex post real interest rate and RGDP growth are positively correlated.

    But maybe I underestimate the possibility of zero nominal interest rates during a rapid economic expansion with NGDPLT. Then I wonder what is the problem with that? The only difficulty I’m aware of with the ZLB is that it is harder for monetary policy to be more expansionary. But that is typically not a problem associated with economic booms. Is the worry that monetary policy would hold the economy back from an even larger expansion? It seems like a nice problem to have.

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