Download Comments on Athanasios Orphanides` The Quest For Prosperity

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.
• 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
• 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
• 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
• 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
• 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
Maybe not so prudent recently
(using real time data (Fig 20))
Percent
10
8
GDP Growth Rate
Rule
/
6
Taylor Rule
\
4
\
Federal Funds Rate
2
0
90:3
91:1
91:3
92:1
92:3
93:1
93:3
94:1
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
• 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