The Yellen Rules - Monetary Policy Legislation and Economic Performance
Analyzing the adoption of policy rules by the Fed, proposed legislation, and criteria for economic performance, this content delves into the implications for long-term economic stability. The discussion elaborates on Taylor rules, real-time data analysis, and considerations for Fed policy post the Great Recession.
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The Yellen Rules The Yellen Rules Alex Nikolsko-Rzhevskyy Lehigh University David Papell and Ruxandra Prodan University of Houston Monetary Rules for a Post-Crisis World Mercatus-CMFA Academic Conference, September 7, 2016 Nikolsko-Rzhevskyy, Papell, Prodan 1 1 1
The Yellen Rules Policy Rule Legislation Proposed by John Taylor in 2011 Cato Journal By the End of 2015 Legislation Passed House Financial Services Committee Senate Banking Committee House of Representatives The Fed Chooses the Rule Fed is Not Forced to Adopt the Taylor (1993) Rule Nikolsko-Rzhevskyy, Papell, Prodan 2
The Yellen Rules Policy Rule Legislation Suppose the Fed Were to Adopt a Policy Rule Legislated To Preclude Legislation Fed Preference for a Policy Rule What Rule Should the Fed Adopt? Three Criteria Consistency with Long-Term Economic Performance Consistency with Fed Policy Following the Great Recession Consistency with Projected Fed Policy First Criteria Normative - Second and Third Pragmatic Nikolsko-Rzhevskyy, Papell, Prodan 3
The Yellen Rules Taylor Rules Balanced it = t + 0.5 ( t 2.0) + 0.5 yt + R* R* = 2 in Taylor (1993) R* = Laubach and Williams R*t in Yellen (2015) Output Gap Tilting it = t + 0.5 ( t 2.0) + 1.0 yt + R* R* = 2 in Yellen (2012) Inflation Gap Tilting it = t + 1.0 ( t 2.0) + 0.5 yt +R* Nikolsko-Rzhevskyy, Papell, Prodan 4
The Yellen Rules Real-Time Data Inflation GDP/GNP Deflator for 1965 - 2015 Core PCE for 2009 - 2016 Output Gap Quadratic Detrended Real GDP/GNP for 1965 - 2015 CBO for 2009 - 2016 Policy Rate Federal Funds Rate for 1965 2008 and 2016 Shadow FFR from Wu and Xia (2016) for 2009 - 2015 Nikolsko-Rzhevskyy, Papell, Prodan 5
The Yellen Rules Real-Time Data Equilibrium Real Interest Rate Two Trend Growth for Previous 10 Years Laubach and Williams (2003) Real-Time Since 2005 Holston, Laubach and Williams (2016) Real-Time Since 2005 Nikolsko-Rzhevskyy, Papell, Prodan 6
The Yellen Rules Consistency with Long-Term Economic Performance Policy Rules and Economic Performance Nikolsko-Rzhevskyy, Papell, and Prodan (2016) Policy Rule Deviations Prescribed FFR Actual FFR Rules-Based or Discretionary if Small or Large Quadratic Loss Functions Loss = (( *)2 + (U U*)2) Quadratic Loss Ratios Ratio of Loss in Discretionary and Rules-Based Periods Good Policy Rules have Large Loss Ratios Nikolsko-Rzhevskyy, Papell, Prodan 7
The Yellen Rules Deviations from the Original Taylor Rule Nikolsko-Rzhevskyy, Papell, Prodan 8
The Yellen Rules Discretion to Rules Loss Ratios 100 Taylor Rules Coefficients on Inflation and Output Gaps Between 0.1 and 1.0 Increments of 0.1 Benchmark Equal Weights on Inflation and Unemployment Loss * = R* = 2 Threshold for Deviations = 2.0 Policy Lag of 6 Quarters Change Weights, R*, Threshold, and Lags Nikolsko-Rzhevskyy, Papell, Prodan 9
The Yellen Rules Discretion to Rules Loss Ratios 1:1 Weights, Threshold=2%, R*=2% and *=2%, 6-Quarter Lag Nikolsko-Rzhevskyy, Papell, Prodan 10
The Yellen Rules Quintiles of the Quadratic Loss Ratios for Policy Rules Inflation Gap Tilting Rule (? = 1.0,? = 0.5) Balanced Rule Output Gap Tilting Rule (? = 0.5,? = 1.0) (? = 0.5,? = 0.5) R* = 2 1 2 4 R* = Trend Growth 1 3 4 R* = LW 1 3 5 R* = HLW 1 3 5 Nikolsko-Rzhevskyy, Papell, Prodan 11
The Yellen Rules Consistency with Long-Term Economic Performance Strong Preference for Inflation Gap Tilting Rules Result Generalizes Beyond These 12 Rules Robust to Many Variations Laubach and Williams (2016) Value of R* Affects Intercept of Taylor Rule Point-for-Point Estimates of R* Very Uncertain Advocate Strong Response to Inflation Decrease Importance of Estimating R* Correctly Consistent with Our Results Nikolsko-Rzhevskyy, Papell, Prodan 12
The Yellen Rules Consistency with Fed Policy Following the Great Recession Pragmatic Rather than Normative Fed Won t Adopt Rule that is Inconsistent with Recent Policy Average Deviations Absolute Value of Deviations Similar Deviations Based on Current Data Policy Continuity Nikolsko-Rzhevskyy, Papell, Prodan 13
The Yellen Rules Balanced Rules (? = 0.5,? = 0.5) Nikolsko-Rzhevskyy, Papell, Prodan 14
The Yellen Rules Output Gap Tilting Rules (? = 0.5,? = 1.0) Nikolsko-Rzhevskyy, Papell, Prodan 15
The Yellen Rules Inflation Gap Tilting Rules (? = 1.0,? = 0.5) Nikolsko-Rzhevskyy, Papell, Prodan 16
The Yellen Rules Average Deviations and Last Quarter Deviation for All Rules Inflation Gap Tilting Rule (? = 1.0,? = 0.5) Balanced Rule (? = 0.5,? = 0.5) Output Gap Tilting Rule (? = 0.5,? = 1.0) Last quarter deviation Last quarter deviation Last quarter deviation Avg. Avg. Avg. deviations deviations deviations 1.58 1.76 0.43 1.44 1.74 -0.75 R* = 2 0.83 1.01 -0.32 0.94 1.24 -1.26 R* = Trend Growth -0.24 -0.06 -1.39 -0.37 -0.08 -2.57 R* = LW -0.15 0.03 -1.30 0.08 0.38 -2.12 R* = HLW Nikolsko-Rzhevskyy, Papell, Prodan 17
The Yellen Rules Consistency with Projected Fed Policy Compare Prescribed and Projected Federal Funds Rate Pragmatic Rather than Normative Federal Funds Rate and Core PCE Projections from SEP Median Projections for End of 2016, 2017, 2018 and Longer Run FOMC Meetings for December 2015, March 2016, and June 2016 Output Gap Projections from CBO Includes August 2016 Update CBO Projects Zero Output Gap Starting End of 2016 Taylor (1993) and Yellen (2012) Rule Projections Identical Nikolsko-Rzhevskyy, Papell, Prodan 18
The Yellen Rules Taylor (1993) and Yellen (2012) Rules Prescribed and Projected FFR December 2015 SEP March 2016 SEP June 2016 SEP Projected FFR Projected FFR Projected FFR Prescribed FFR Prescribed FFR Prescribed FFR 1.4% 0.9% 0.9% 3.4% 3.4% 3.6% 2016 2.4% 1.9% 1.6% 3.8% 3.7% 3.9% 2017 3.3% 3.0% 2.4% 4.0% 4.0% 4.0% 2018 4.0% 3.3% 3.0% 4.0% 4.0% 4.0% Longer Run Nikolsko-Rzhevskyy, Papell, Prodan 19
The Yellen Rules Consistency with Projected Fed Policy Yellen (2015) Rule Uses Laubach and Williams R* Can t Compute R* Projections from SEP and CBO Data Can t Compare Prescribed and Projected FFR Calculate Projected R* Conditional of Projected FFR Laubach and Williams R* 0.19 in 2016:Q1 0.18 in 2016:Q2 Nikolsko-Rzhevskyy, Papell, Prodan 20
The Yellen Rules Yellen (2015) Rule R* Conditional On Projected FFR December 2015 SEP March 2016 SEP June 2016 SEP Inflation Gap Tilting Inflation Gap Tilting Inflation Gap Tilting Balanced Balanced Balanced 0.2% -0.3% -0.5% 0.0% -0.5% -0.7% 2016 0.6% 0.3% -0.2% 0.6% 0.2% -0.3% 2017 1.3% 1.0% 0.4% 1.3% 1.0% 0.4% 2018 1.5% 1.3% 1.0% 1.5% 1.3% 1.0% Longer Run Nikolsko-Rzhevskyy, Papell, Prodan 21
The Yellen Rules Yellen (2016) Rule from Jackson Hole Symposium Taylor Rule with an Unemployment Gap it = R* + t + 0.5( t *) 2.0(Ut U*) R* = 1%, U* = 4.8 %, is Core PCE, and * = 2 Coefficient of -2.0 Consistent with 1.0 on Output Gap Okun s Law Coefficient = 2 Unemployment Gap Tilting Policy Rule Yellen (2016) and Reifschneider (2016) Consistent with FOMC Behavior from 2000 - 2008 Nikolsko-Rzhevskyy, Papell, Prodan 22
The Yellen Rules Consistency with Long-Term Economic Performance Same Methodology as for Output Gap Rules No Long-Term Real-Time Data for U* Robert Gordon s Text (Various Editions) for 1965 2008 SEP Projections for 2009 2016 No Long-Term Real-Time Data for PCE Inflation Use GDP/GNP Inflation Calculate Quadratic Loss Ratios for 100 Policy Rules Yellen (2016) Rule is in the Fourth Quintile Output Gap Version with R* = 1 is in the Fifth Quintile Yellen (2016) Rule Not Consistent with First Criterion Nikolsko-Rzhevskyy, Papell, Prodan 23
The Yellen Rules Consistency with Fed Policy Following the Great Recession Average Deviation = -2.41 Percent Second Highest Among the 13 Rules Current Deviation = 1.89 Percent Largest Among the 13 Rules Yellen (2016) Rule Not Consistent with Second Criterion Nikolsko-Rzhevskyy, Papell, Prodan 24
The Yellen Rules Yellen (2016) Rule Nikolsko-Rzhevskyy, Papell, Prodan 25
The Yellen Rules Consistency with Projected Fed Policy Projected Path of the Federal Funds Rate Core PCE and UnemploymentProjections from June SEP Projected Federal Funds Rate 2.75 Percent at End of 2016 3.25 Percent at End of 2017 3.4 Percent at End of 2019 3.0 Percent in Longer Run Very Different than Path of Fed Projections Yellen (2016) Rule Not Consistent with Third Criterion Nikolsko-Rzhevskyy, Papell, Prodan 26
The Yellen Rules Conclusions Propose Three Criteria for a Fed Policy Rule Consistency with Long-Term Economic Performance Consistency with Fed Policy Following the Great Recession Consistency with Projected Fed Policy Inflation Gap Tilting Version of Yellen (2015) Rule Higher Coefficient on Inflation Gap than on Output Gap LW Time Varying Equilibrium Real Interest Rate Only Rule Consistent with All Three Criteria Close Correspondence with Dec 2015 SEP Yellen (2016) Rule Not Consistent with Any Criterion Nikolsko-Rzhevskyy, Papell, Prodan 27
