I am on record as an overall admirer of The Ben Benank’s work as Fed Chair. I believe that the Fed acted decisively at the height of the crisis and that QE, if nothing else, did stave off deflation.
But my oh my oh my, the Fed has really made a bollux out of forward guidance. This however, I do not blame on Bernanke. I feel like it was pushed on him by outside economists and other FOMC members (Evans and Yellen, you know I’m talking about you!). I just can’t believe Ben would think such cheap talk would seriously move the economy.
First they went with calendar based guidance. You know, the Fed promising to keep interest rates low until the rivers run dry. But the economy did not really respond. So the Fed, under intense pressure to “do more”, switched to outcome based guidance. You know, the Fed promising to keep interest rates low until unemployment fell below 6.5%.
Well, we now sit on the cusp of a 6.5% unemployment rate, but we’ve gotten there largely for the wrong reason, namely a persistent decline in labor force participation. Employment has still not hit pre-crisis levels and nobody is very happy with the state of the economy, least of all Evans and Yellen of the 6.5% pronouncement.
Now they have a big problem, which is rationalizing not raising rates when the 6.5% threshold is crossed. We are getting mired, Bill Clinton-like, in a maze of Talmudic interpretations of what words mean and what can be weaseled on without losing the Fed’s vaunted credibility.
I guess someone should have read Williamson on incomplete contracts? Or any right wing public choice nut on unintended consequences of government policies?
Maybe some folks on the FOMC should stop worrying about how to rehabilitate forward guidance and start thinking more humbly about what monetary policy can actually do.
I’ve been to a lot of DSGE seminars. At Duke, at the Fed, heck we even have ’em in Oklahoma! One thing most have in common is that they use the Calvo rule to implement price stickiness.
The Calvo rule is a shortcut which assumes that a firm has a fixed probability of getting a chance to change its price in any given period. This probability is independent of how far their price is away from the optimum or how long it’s been since they changed prices.
Time after time I’d object, and time after time I’d be told that the Calvo rule was a benign modeling “trick” that made things less intractable with no real influence on the results.
This morning, I was pleased to discover the research of a young Chicago (Booth) researcher named Joseph Vavra. He’s doing a lot of very interesting work, but what really caught my attention was his piece, The Empirical Price Duration Distribution and Monetary Non-Neutrality.
Here’s the abstract:
Allowing for price adjustment probabilities that vary with the number of periods since an item last adjusted (duration-dependenceí) provides a significantly better fit of observed price spells in CPI and grocery store micro data than the Calvo model, even if the latter is extended to incorporate item-specific adjustment probabilities. Furthermore, extending the Calvo model to match both duration-dependence and cross-item heterogeneity, as observed in the micro data, leads to an increase of 100-230% in monetary non-neutrality, even with no strategic-complementarities. As much as half of this increase is driven by duration-dependent adjustment probabilities.
Nicely played, sir, kudos. Not so innocuous after all, that Calvo rule.
Given how our profession often works, I fear he may have trouble getting this published. But, since he has R and Rs at the QJE and Econometrica, I think he’ll be OK no matter what happens to this piece.