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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

Comments on Athanasios Orphanides’ The Quest For Prosperity Without Inflation

John B. Taylor

Stanford University

January 8, 2000

overview
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.
constructive criticism
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.
the key assumption
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
reasons to question the assumption and thus the conclusion
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
reasons to worry about reacting to y only rather than to y
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
residuals as mistakes
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.”
conclusion
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