speeches · March 19, 2009

Regional President Speech

James Bullard · President

INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION MONETARY POLICY IN A GLOBAL RECESSION JamesBullard* FederalReserveBankofSt. Louis MonetaryPolicyintheCurrentCrisis BanquedeFranceandToulouseSchoolofEconomics Paris,France March20,2009 AnyopinionsexpressedherearemineanddonotnecessarilyreflectthoseofotherFederalOpenMarketCommitteeemembers. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION RESEARCH AND POLICY Takethisopportunitytotrytomerge: 1 Somefrontierresearch... 2 ...withsomepressingpolicyproblemsassociatedwiththecurrent crisis. Wecannotsolvealltheseproblemstoday. Butgoodresearchideascanhelpusthinkaboutpragmatic policyoptions. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION GLOBAL RECESSION WeareinasharprecessionintheU.S.andglobally. Globalaspectsunprecedentedinthepostwarera. Financialmarketturmoilcontinuing. Macroeconomicexpectationsunsettled,fluid. Suggestsmanypossibleoutcomes. Theglobalpolicyresponsemaybecritical. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION NEAR-ZERO NOMINAL INTEREST RATE POLICIES TheFederalReservemovedtheU.S.policyrateclosetozeroin December2008. ECBloweringrates. BankofEnglandmovingclosertozero. BankofJapannearzero. Globalzerointerestratepolicy? INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION MONETARIST EXPERIMENTS, THEN AND NOW Taylorrulecallingfor 6%U.S.nominalinterestrate(!) (cid:0) Tokeepstabilizationpolicyactiverequiresashiftinthinking. Previoussimilarshiftinthinking: Volcker1979. Moreemphasisonmonetaryquantities. 1979:Achoicetoimplementpolicyinawaythatwouldget inflationundercontrol. 2008:ThrustupontheFedbyevents. Butwhatisthenatureofthisnewpolicy? INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION INTELLECTUALLY UNPREPARED Volcker’smonetaristexperimentwontheearly1980sbattle againstinflation. 1980smonetarytheoryreferredalwaystomoney. Twointellectualdevelopmentssincethenhavelefttheeconomics professionlargelyunpreparedforcurrentcircumstances. Kydland,Prescott,Lucas:allowtheeconomytooptimallyreactto shocks.Don’tworrytoomuchaboutbusinesscycles.Monetary policy‘over-emphasized.’ Rotemberg,Woodford,Taylor:totheextentwecanusemonetary stabilizationpolicyeffectively,interestraterulesareasensibletool. Result: WithZIRP... ...stabilizationpolicyrunsagroundintellectually. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION QUANTITATIVE EASING Near-zeropolicyrateshaveledtomuchdiscussionof “quantitativeeasing.” Goalsforthisaddress: Trytooffersomeclarityandperspectiveontheseissues. Prepareforthecomingeraofnear-zeropolicyratesglobally. Themes: 1 Littleintrinisicdifferencebetweennominalinterestratetargeting andmonetarytargeting. 2 Avoidingdeflationarytrapdynamicsmaydependonfiscal policy. 3 Globalaspectsofpolicycoordination: whattothink? INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION A BENCHMARK MODEL BecauseofZIRP,thereiscurrentlyalotofdiscussionabout quantitatively-basedmonetarypolicy. ButsinceTaylor(1993),thediscussionhasmovedtheotherway, towardinterestraterules. “Rationalizingwhatcentralbanksalreadydo.” Thrustofthatdiscussion: onedoesnothavetorefertomoney whenimplementingmonetarypolicy. Tothinkaboutthis: ConsiderthebasicmodelfromWoodford(2003,InterestandPrices, PrincetonUniversityPress). Thinkofshort-termnominalinterestratesasbeinglow,butnot zero. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION MONETARY IMPLEMENTATION WithintheNKmodel,anydesiredstabilizationpolicycouldbe implementedviaeitherinterestratemovementsormovements inthestockofmoney. Atsomelevel,thishastobetrue. Meaning: Wedonothavetoimplementviamoney... ...orevenrefertomoney... ...butwecanimplementviamoneyifdesired. Thisisanimportantconceptinthecurrentenvironment. Whydesirednow? Consider: Christiano,MottoandRostagno(2004)–“TheGreatDepression andtheFriedmanSchwartzhypothesis”:amonetarybaserule wouldhaveavoidedthedepression. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION “M” AND MONETARY POLICY IN THE NK MODEL ManyhavelookedforaroleformoneyintheNKframework. InthebasicNKmodel,itisnotnecessarytomakereferenceto money. Manyargumentsaboutthis. ButeveninthebasicNKmodel,youcanpursuestabilization policyviamovementsinthemoneystock. Innormaltimes,youmaynotwanttodothis. Inextraordinarytimes,youmaywanttoturntothisoption. Thisiswhatishappeningnowincentralbankpolicyworldwide. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION A CONCEPTUAL QUESTION TheNKmodelconsistsoffourequations. Afourthequationdescribesthedemandformoneyasafunction ofthenominalinterestrate. Itisadecoupledequation: Itisnotneededtofindthe equilibriumallocationsintheeconomy. Aquestionsometimesasked: isitnotpossibletoinvertthe moneydemandequation,expressingthesystemintermsofa monetaryruleinstead,withoutreferencetointerestratesatall? Answer: Itispossible,butthemonetaryruleisnotliketheones normallystudiedintheearlierliterature. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION PRELIMINARIES Assumetheinflationtargetiszero. AdoptWoodford’smoney-in-the-utilityfunctionspecification. Assumethatmoneydoesnotpayinterest. Allvariablesareexpressedasdeviationsfromtheirsteadystate equilibriumortargetvalues. Thereisnoassumptionconcerningthezerobound: Thisisa localanalysisforpositivenominalinterestrates. Thinkofnominalinterestratesasbeinglowbutpositive. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION FOUR EQUATIONS Considerfourequations: x t = E t x t+1 σ[r t E t π t+1 ]+e x,t (1) (cid:0) (cid:0) π t = κx t +βE t π t+1 +e π,t (2) r = ϕ π +ϕ x (3) t π t x t m = η x η r (4) t x t (cid:0) r t Equations(1)and(2)arestandard. Equation(3)isanadhocTaylorrulewithpolicyparameters ϕ π and ϕ . x Equation(4)isthemoneydemandrelationcomingfromthe money-in-the-utilityfunctionspecification. Normally,themoneydemandequation(4)isviewedas decoupled,andsoignored. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION DETERMINACY Substitutingequation(3)intoequation(1)createsa two-dimensionalsystemwithdeterminacycondition 1 β ϕ + (cid:0) ϕ >1. (5) π κ x Equilibriumdeterminacydependsonpolicyparameterchoices. Policymustbe“aggressiveenough”topreventself-fulfilling fluctuationsunrelatedtofundamentalshocks. Wecanchooseoptimalvaluesfor ϕ and ϕ subjecttothe π x determinacycondition. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION AN ALTERNATIVE ThrowouttheTaylorrule,equation(3). Invertthemoneydemandrelation: η x m r = x t (cid:0) t (6) t η r Substitute(6)into(1). SpecifyamoneysupplyruletoreplacetheTaylorrule: m = µ π +µ x (7) t π t x t withnewpolicyparametersµ andµ . π x Substitute(7)into(1). Thiscreatesatwo-dimensionalsystem,as before. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION AN EQUIVALENCE Thenewsystemistwodimensional,withvariablesx andπ . t t Thereisnoreferencetonominalinterestrates. Thenewsystemisidenticaltotheoriginaloneif η ϕ = µ (8) r π (cid:0) π η ϕ = η µ . (9) r x x(cid:0) x Sinceµ andµ arearbitrarypolicyparameters,wecanalways π x choosetheirvaluesappropriatelytomeettheseconditions. Appropriatechoicesmeansdeterminacyconditionsarealsomet. Wecanoptimizechoicesofµ andµ toobtaintheoptimal π x allocationsgivendeterminacy. Fromthisperspective,thereislittletochoosebetweeninterest rateormonetaryimplementations. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION REMARKS Feedbackformoneysupplyrulesunusual. Amonetaryfeedbackrulecanaccomplisheverythinganinterest raterulecanaccomplish. Itisstillarule. Allissuesaboutcommitmentandannouncing policypathsarestillrelevant. Settingµ = µ =0,“moneydoesnotmatter,”mayyield π x determinacybutwouldingeneralbefarfromtheoptimalpolicy. Switchingto“quantitativemonetarypolicy”atlownominal interestrateswithoutthinkingaboutissueslikethismayleadto policyerrors. Objectionstoquantitativemonetarypolicyarebettercouchedin termsofpracticalconsiderations. Inaddition,interestrateruleshaveaclearproblem—theycan generatedeflationarytraps. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION RECENT DATA Deflationisarealpossibilityinthecurrentenvironment. Aglobalrecessionthatcontinueslongerthancurrently anticipatedcouldcreateadeflationarypsychology. Ifthisbecomesentrenched,wecouldfaceanextendedperiodof decliningprices. WehavetheexampleofJapan. Animportantnear-termgoalformonetarypolicyistoprevent thisoutcome. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION DEFLATIONARY TRAPS TheJapaneseexperiencespawnedaliterature. Benhabib,Schmitt-Grohe,andUribe(2001,JET):“Theperilsof Taylorrules.” Theycombinedthefollowingfeatures: ATaylor-typepolicyrulewhichis‘active.’ Azeroboundonnominalinterestrates. AFisherrelation:rt =ρ+Etπ t+1 . Thesefeaturescombinetoproducea‘second’steadystateaway fromthetargetedsteadystate. Thisnewsteadystatehasinflationsubstantiallybelowtarget andverylownominalinterestrates. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION THE RISK OF A DEFLATIONARY TRAP TheBenhabibetal. storyseemsparticularlyrelevantinthe currentenvironment. Policyratesaremovinglowerworldwide. Alarge,globalshock. Whyworryaboutdeflation? Nominalcontracting. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION A COMFORTING RESULT Onequestiontoaskwhentherearemultiplesteadystatesis whichsteadystateisstableunderlearningdynamics. Evans,Guse,andHonkapohja(2008,EER)didthisanalysisina NKmodel. Theyshowthatthetargetedsteadystateislocallystable,butnot globallystable,inthelearningdynamics. Thisiscomforting. Still,alargeshockcouldsendtheeconomyintowhattheycalla deflationaryspiral. Howtopreventthis? INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION AVOIDING DEFLATIONARY TRAPS Oneideaistobeparticularlyaggressiveasinterestratesare beinglowered. Onceinflationpassesacertainthresholdbelowtheinflation target,theninterestrateswouldbeloweredtonearzerorapidly. Thispolicydoesnotreallysolvetheproblem. Itdoesenlargethebasinofattractionforthetargetedsteadystate... ...bycreatinganewsteadystatestillfurtherfromthetargeted equilibrium. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION AVOIDING DEFLATIONARY TRAPS: FISCAL POLICY Anotherideaistopursueanaggressivefiscalpolicy. Insidethemodel,fiscalpolicyispassiveinthesenseofLeeper (1991). Anincreaseinrealgovernmentdebtisfinancedbylump-sum taxes. Inthissetting,anincreaseingovernmentconsumptioncanputa flooroninflationsufficienttokeeptheeconomyinthebasinof attractionofthetargetedsteadystate. Intriguing. Seemsliketherighttypeofanalysis. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION AVOIDING DEFLATIONARY TRAPS: EGH FIG. 1 INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION AVOIDING DEFLATIONARY TRAPS: EGH FIG. 4 INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION GLOBAL POLICY Internationalpolicycoordinationisofcoursedifficult. Formonetarypolicy,modelsareonlyrecentlyavailable. Someliteraturesuggeststhatgainsfromcoordinationmaynot bethatlarge. Implication: don’tworryaboutalackofcoordination. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION COORDINATION FROM ANOTHER PERSPECTIVE BullardandSingh(2008,JME). MultipleNKeconomies. MultiplepolicymakersfollowingTaylor-typerules. EachcountryfocusesonCPIinflation,whichincludesimported goodsprices. Equilibriumisglobal. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION MORE ON COORDINATION Determinacyconditionsdependonpolicymakersworldwide. Indeterminacyoftheworldwideequilibriumcanbecausedbya singlepolicymaker. Inthismodel,theredoesnotappeartobemuchthatremaining countriescandotofixtheproblem. Ifthecountrypursuingthepoorpolicyislarge... ...endogenousvolatilitycouldreverberateworldwide. Worrisome. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION LESSONS ON COORDINATION Thenatureofworldwideequilibriumdependsontheactionsof allpolicymakers,especiallymajorplayers. Maybeaboutmorethana‘smallgain’frompropercoordination. Morelike: Thestructureofworldequilibrium,thepotentialfor endogenousvolatility. Antherexample: worldwidedeflationarytrap. MultiplecountryversionsofBenhabibetal.? INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION CONCLUSION Newenvironmentcharacterizedby: worldwiderecession. verylowpolicyratesglobally. possibledeflationarytrap. Themes: Quantitativeapproachestopolicyarefeasible. Assessingdeflationarytrappotentialrequiresacredibleanalysisof dynamics. Coordination:maybemoreimportantthancommonlyrecognized. INTRODUCTION THEENDOFINTERESTRATERULES? DEFLATIONARYTRAPS GLOBALPOLICYCOORDINATION CONCLUSION CONCLUSION Movingtoquantitativeapproachestopolicyisfeasibleandis goingonrightnow. Wecannotlosesightofalloftheotherimportantlessonslearned overthepast15years. Credibility,transparency,commitmentremainimportant. AdeflationarytraplikeJapan’sisaclearnear-termrisk. Possiblyfiscalpolicymoveswillhelptoavoidthesedynamics. Worldwide? Internationalpolicycoordination. Lesstodowithsmalladditionalutilitygains. Moretodowiththestructureoftheglobalequilibriumandthe potentialforendogenousvolatility.

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APA

James Bullard (2009, March 19). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_20090320_james_bullard

BibTeX

@misc{wtfs_regional_speeche_20090320_james_bullard,
  author = {James Bullard},
  title = {Regional President Speech},
  year = {2009},
  month = {Mar},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_20090320_james_bullard},
  note = {Retrieved via When the Fed Speaks corpus}
}