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Comments on Athanasios Orphanides’ The Quest For Prosperity Without Inflation

Comments on Athanasios Orphanides’ The Quest For Prosperity Without Inflation . John B. Taylor Stanford University January 8, 2000. Overview. “Instant replay” of monetary policy decisions from the start of the Great Inflation through 1993.

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Comments on Athanasios Orphanides’ The Quest For Prosperity Without Inflation

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  1. Comments on Athanasios Orphanides’ The Quest For Prosperity Without Inflation John B. Taylor Stanford University January 8, 2000

  2. Overview • “Instant replay” of monetary policy decisions • from the start of the Great Inflation through 1993. • Postulates what information was available and was used to make the decisions • Definition of “real time” data • Calls attention to the problems with historical studies that simply use current data to evaluate past policy decisions. • Clarida, Gali, Gertler, Judd, Rudebusch, Taylor • Dramatizes the uncertainty about potential GDP • Also about deviations of actual GDP from potential. • Criticizes monetary policy rules with the level rather than the change in such deviations.

  3. Constructive criticism • Pointing out the implications of uncertainty in measuring potential GDP is useful and welcome. • an issue about which we are all aware • it is why there is so much research on estimating potential • Historical charts are wonderful. • However, the measure of uncertainty is • flawed conceptually, • exaggerated in magnitude • overemphasized in comparison with other problems • One is left with serious doubts about the message.

  4. The key assumption • Historical decisions with a monetary policy rule require old, un-revised data on inflation, real GDP and potential GDP • no problem for real GDP or inflation • But there is a problem about potential: • no record of a potential series produced at the Fed in 1960s and 1970s • Answer to the problem? • Assume that the Fed used the series produced by the White House • Analogous to assuming a can opener

  5. Reasons to question the assumption and thus the conclusion • Potential GDP and its growth rate became politicized as early as the late 1960s • Serious economic analysts—like Burns and Greenspan—paid no attention to it • The series shows a GDP gap of 15 percent in the mid 1970s—comparable to the Great Depression! • Economists knew that the revision in 1977 was still too small. • Even though paper claims that “this could not have been know in 1997.” • Done by a lame-duck CEA that still pulled back from staff estimates (e.g.. 4.9 percent u*) • Concept of potential GDP was a max not a mean

  6. Reasons to worry about reacting to y only rather than to y • Overshooting: • Policy is too easy when economy is way above capacity and growing at potential growth rate • Undershooting: • Policy is too tight when economy is below capacity and growing at potential growth rate • Econometric model-based evidence: • Rudebusch (1999): modern forward/backward looking model (with estimates of uncertainty in potential) • Taylor (1985) VAR type model • Also worry about loaded words: • “prudent” versus “active,” with cites to Friedman Meltzer

  7. Maybe not so prudent recently (using real time data (Fig 20))

  8. Residuals as Mistakes • Deviations from policy rules cannot be blindly interpreted as mistakes: some discretion is needed. • Clearly the inflationary policy in the late 1960s and 1970s was a mistake. • But the response to the 1987 stock market crash was not a mistake. • What about the high interest rates at the end of the great disinflation that were a deviation from a policy rule? • Strongly disagree with the following unqualified statement: “This ‘mistake,’ Taylor concludes, accounts for the dismal performance of output in the early 1980s and the depth of the 1982 recession.”

  9. Conclusion • Uncertainty in measuring potential is a problem • Down weight output deviations: Rudebusch, Smets • 0.5 is already pretty low, but perhaps it could be lower • 0.0 seems too low • 1.0 seems too high • Spend a lot of time researching productivity growth and unemployment measures • Look at other variables, such as capacity utilization or unemployment, that help estimate the GDP deviations

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