Friday, August 26, 2011

Gerlach/Moretti vs. Taylor (amv)

Stefan Gerlach and Laura Moretti provide a very suggestive analysis of monetary policy before the crisis (© They essentially argue that - in contrast to what John Taylor wants us to believe - low policy rates during 2002-5 do not indicate an expansive stance of monetary policy. Rather, the Fed simply responded (sluggishly) to a fall in the Wicksellian rate (determined by real data alone). As a theorist and historian of economics, and since I make this point repeatedly,  I especially welcome the following statements:
"Furthermore, standard macroeconomic models hold that monetary policy has, at most, temporary effects on real variables, and thus they have a difficult time explaining this decline [the decline in 10y TIPS-yields]. Hence, a reduction in the federal funds rate – a nominal overnight rate – cannot have depressed 10-year real interest rates over a decade. In turn, this suggests that monetary policy played at most a limited role in setting the stage for the crisis." [my emphasis]
"[T]he Wicksellian interest rate is independent of monetary policy but may change in response to real economic disturbances, such as to changes in economic growth. Since deviations of the real interest rate from the Wicksellian interest rate are temporary, long-term real interest rates, represented by the yields on TIPS in the empirical analysis above, are largely driven by expectations of the Wicksellian rate." [my emphasis]
See also: Michael Woodford about his distaste for QE3, his hopes for better Fed-communication in general, and his advice to Bernanke with respect to his Jackson Hole speech today.