The economic outlook

Presentation to the Stanford Institute for Economic Policy Research, State of the West Symposium, Stanford, California, February 4, 2011Economic conditions - United States

Robust estimation and monetary policy with unobserved structural change

This paper considers the joint problem of model estimation and implementation of monetary policy in the face of uncertainty regarding the process of structural change in the economy. We model unobserved structural change through time variation in the natural rates of interest and unemployment. We show that certainty equivalent optimal policies perform poorly when there is model uncertainty about the natural rate processes. We then examine the properties of combined estimation methods and policy rules that are robust to this type of model uncertainty. We find that weighted averages of sample means perform well as estimators of natural rates. The optimal policy under uncertainty responds more aggressively to inflation and less so to the perceived unemployment gap then the certainty equivalent policy. This robust estimation/policy combination is highly effective at mitigating the effects of natural rate mismeasurement.Monetary policy ; Uncertainty ; Econometric models ; Interest rates

Monetary policy in a low inflation economy with learning

In theory, monetary policies that target the price level, as opposed to the inflation rate, should be highly effective at stabilizing the economy and avoiding deflation in the presence of the zero lower bound on nominal interest rates. With such a policy, if the short-term interest rate is constrained at zero and the inflation rate declines below its trend, the public expects that policy will eventually engineer a period of above-trend inflation that restores the price level to its target level. Expectations of future monetary accommodation stimulate output and inflation today, mitigating the effects of the zero bound. The effectiveness of such a policy strategy depends crucially on the alignment of the public's and the central bank's expectations of future policy actions. In this paper, we consider an environment where private agents have imperfect knowledge of the economy and therefore continuously reestimate the forecasting model that they use to form expectations. We find that imperfect knowledge on the part of the public, especially regarding monetary policy, can undermine the effectiveness of price-level-targeting strategies that would work well if the public had complete knowledge. For low inflation targets, the zero lower bound can cause a dramatic deterioration in macroeconomic performance with severe recessions occurring with alarming frequency. However, effective communication of the policy strategy that reduces the public's confusion about the future course of monetary policy significantly reduces the stabilization costs associated with the zero bound. Finally, the combination of learning and the zero bound implies the need for a stronger policy response to movements in the price level than would otherwise be optimal and such a rule is effective at stabilizing both inflation and output in the presence of learning and the zero bound even with a low inflation target.Monetary policy ; Inflation (Finance)

Will the financial crisis have a lasting effect on unemployment?

To understand Fed policy at this point, you have to look at this whole picture. We have good GDP growth, but a yawning shortfall of employment and output from potential levels. ; Presentation to the Chicago Booth Graduate School of Business Alumni Club of San Francisco, San Francisco, Ca, February 22, 2011Financial crises ; Unemployment

Sailing into headwinds: the uncertain outlook for the U.S. economy

Presentation to Joint Meeting of the San Francisco and Salt Lake City Branch Boards of Directors. Closing Luncheon. Salt Lake City, UT, September 8, 2010Economic conditions - United States ; Economic forecasting - United States

The economic outlook: moving forward on a bumpy road

The recent softness in the economic data looks much more like a bump in the road of what we already thought would be a gradual recovery, rather than a swerve into the ditch. ; Presentation to community leaders' luncheon, Portland, Oregon, July 28, 2010Economic conditions - United States ; Economic forecasting - United States ; Inflation (Finance)

The economic outlook

Presentation to the Seattle Community Development Roundtable, Seattle, WA, November 15, 2010Economic conditions - United States ; Economic forecasting - United States

Heeding Daedalus: Optimal inflation and the zero lower bound

This paper reexamines the implications of the zero lower bound on interest rates for monetary policy and the optimal choice of steady-state inflation in light of the experience of the recent global recession. There are two main findings. First, the zero lower bound did not materially contribute to the sharp declines in output in the United States and many other economies through the end of 2008, but it is a significant factor slowing recovery. Model simulations imply that an additional 4 percentage points of rate cuts would have kept the unemployment rate from rising as much as it has and would bring the unemployment and inflation rates more quickly to steady-state values, but the zero bound precludes these actions. This inability to lower interest rates comes at the cost of $1.7 trillion of foregone output over four years. Second, if recent events are a harbinger of a significantly more adverse macroeconomic climate than experienced over the preceding two decades, then a 2 percent steady-state inflation rate may provide an inadequate buffer to keep the zero bound from having noticeable deleterious effects on the macroeconomy assuming the central bank follows the standard Taylor Rule. In such an adverse environment, stronger systematic countercyclical fiscal policy and/or alternative monetary policy strategies can mitigate the harmful effects of the zero bound with a 2 percent inflation target. However, even with such policies, an inflation target of 1 percent or lower could entail significant costs in terms of macroeconomic volatility.Monetary policy ; Fiscal policy ; Liquidity (Economics)