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The Federal Reserve in a Globalized World Economy
Abstract
The importance of international considerations in the US Federal Reserve System's deliberations has become more and more important over time as global financial crises and events create ever stronger repercussions in the US economy. This book critically evaluates the role of the Federal Reserve System as a player in the international monetary system over the past one hundred years, starting with its initial responsibility under the gold standard and looking ahead to the challenges it will face in the twenty-first century under the fiat standard. The book is based on a conference of the same name held at the Federal Reserve Bank of Dallas in September 2014, as part of the Federal Reserve System's centennial, and contributors include many of the most highly regarded financial historians and policymakers.
... ).The adverse effects of the policies of the United States government reached outside to foreign nations.Taylor (2016) andMishkin et al. (2016) state that the following of monetary policy rules helps not only the United Sates, but also other countries. There were spillover effects of the United States not following the Taylor rule on all those nations that had become accustom to the U.S. following the rule. The "Great Moderation" that was started in the ...
... The "Great Moderation" that was started in the United States and was truly international in scope. In the early years of the twentieth-first century, the Great Moderation gave way to a high inflation in the United States, necessitating foreign countries to try to vainly try to predict the capricious monetary policies that had been the result in the United States(Taylor, 2016;Mishkin et al, 2016). Foreigners accurately predicting U.S. inflation is a factor in foreigners accurately predicting real return on investment on U.S. debt instruments, such as U.S. Treasury bonds and mortgage backed securities, as well as future foreign exchange rates. ...
Knowledge in the economic and banking history of the United States, of the last one hundred years or thereabouts, is necessary in any discussions of even current economic and political policies. This article looks at major economic events in the last century, with some attention also given to surrounding political forces of these events. In 1933, President Franklin Roosevelt, with strong bipartisan support in Congress, was able to pass the Glass-Stegall Act, after taking office in the Great Depression. Politicians in the United States during the approximately twenty-five years prior to the bursting of the housing bubble in 2007 have both used legislation to remove regulations and also made sure that inadequate government personnel were available to audit financial institutions. An important part of confidence is a faith in government regulatory agencies that monitor financial institutions. Lax monetary and regulatory policies can create a real estate bubble. This happened in the most recent economic disaster, the Great Recession. Sometimes the Federal Reserve has pursued reasonable monetary policy and other times inappropriate decreases or increases in the money supply have created havoc in the national economy.
Keywords: banking, Federal Reserve Bank System, financial crisis, Great Depression, Great Recession, Taylor rule for central banks. JEL Classification: G21, E5, G01, N11, N12
... This hypothesis generally implies that business cycle changes are largely exogenous and out-of-thecontrol of policy-makers. In turn, improved performance of macroeconomic policies, in particular better monetary policy, attributes those business cycle changes to policy shifts that align the implemented policy closer to the optimal one (see, e.g., Taylor (2016) on this point) or to a move from passive to active monetary policy (Lubik and Schorfheide (2004)). Substantial changes in the operational frameworks for central banking, increased independence, and improved accountability and transparency have all likely contributed to produce better macroeconomic outcomes. ...
In this paper, I explore the changes in international business cycles with quarterly data for the eight largest advanced economies (US, UK, Germany, France, Italy, Spain, Japan, and Canada) since the 1960s. Using a time-varying parameter model with stochastic volatility for real GDP growth and inflation allows their dynamics to change over time, approximating nonlinearities in the data that otherwise would not be adequately accounted for with linear models [Granger, Clive W.J., Timo Teräsvirta, and Heather M. Anderson. 1991. “Modeling Nonlinearity over the Business Cycle.” In NBER book Business Cycles, Indicators and Forecasting (1993) , edited by James H. Stock and Mark W. Watson, University of Chicago Press.; Granger, Clive W.J. 2008. “Non-Linear Models: Where Do We Go Next – Time Varying Parameter Models?” Studies in Nonlinear Dynamics and Econometrics 12 (3): 1–11.]. With that empirical model, I document a period of declining macro volatility since the 1980s, followed by increasing (and diverging) inflation volatility since the mid-1990s. I also find significant shifts in inflation persistence and cyclicality, as well as in macro synchronization and even forecastability. The 2008 global recession appears to have had an impact on some of this. I ground my empirical strategy on the reduced-form solution of the workhorse New Keynesian model and, motivated by theory, explore the relationship between greater trade openness (globalization) and the reported shifts in international business cycle. I show that globalization has sizeable (yet nonlinear) effects in the data consistent with the implications of the model – yet globalization’s contribution is not a foregone conclusion, depending crucially on more than the degree of openness of the international economy.
... This hypothesis generally implies that business cycle changes are largely exogenous and out-of-thecontrol of policy-makers. In turn, improved performance of macroeconomic policies, in particular better monetary policy, attributes those business cycle changes to policy shifts that align the implemented policy closer to the optimal one (see, e.g., Taylor (2016) on this point) or to a move from passive to active monetary policy (Lubik and Schorfheide (2004)). Substantial changes in the operational frameworks for central banking, increased independence, and improved accountability and transparency have all likely contributed to produce better macroeconomic outcomes. ...
In this paper, I explore the changes in international business cycles with quarterly data for the eight largest advanced economies (U.S.) since the 1960s. Using a time-varying parameter model with stochastic volatility for real GDP growth and inflation allows their dynamics to change over time, approximating nonlinearities in the data that otherwise would not be adequately accounted for with linear models (Granger et al. (1991), Granger (2008)). With that empirical model, I document a period of declining macro volatility since the 1980s, followed by increasing (and diverging) inflation volatility since the mid-1990s. I also find significant shifts in inflation persistence and cyclicality, as well as in macro synchronization and even forecastability. The 2008 global recession appears to have had an impact on some of this. I ground my empirical strategy on the reduced-form solution of the workhorse New Keynesian model and, motivated by theory, explore the relationship between greater trade openness (globalization) and the reported shifts in international business cycle. I show that globalization has sizeable (yet nonlinear) effects in the data consistent with the implications of the model-yet globalization's contribution is not a foregone conclusion, depending crucially on more than the degree of openness of the international economy.
... The " Great Moderation " that was started in the United States and was truly international in scope. In the early years of the twentieth-first century, the Great Moderation gave way to a high inflation in the United States, necessitating foreign countries to try to vainly try to predict the capricious monetary policies that had been the result in the United States (Taylor, 2016;Mishkin et al, 2016). Foreigners accurately predicting U.S. inflation is a factor in foreigners accurately predicting real return on investment on U.S. debt instruments, such as U.S. Treasury bonds and mortgage backed securities, as well as future foreign exchange rates. ...
Knowledge in the economic and banking history of the United States, of the last one hundred years or thereabouts, is necessary in any discussions of even current economic and political policies. This article looks at major economic events in the last century, with some attention also given to surrounding political forces of these events. In 1933, President Franklin Roosevelt, with strong bipartisan support in Congress, was able to pass the Glass-Stegall Act, after taking office in the Great Depression. Politicians in the United States during the approximately twenty-five years prior to the bursting of the housing bubble in 2007 have both used legislation to remove regulations and also made sure that inadequate government personnel were available to audit financial institutions. An important part of confidence is a faith in government regulatory agencies that monitor financial institutions. Lax monetary and regulatory policies can create a real estate bubble. This happened in the most recent economic disaster, the Great Recession. Sometimes the Federal Reserve has pursued reasonable monetary policy and other times inappropriate decreases or increases in the money supply have created havoc in the national economy.
Policy rates have on aggregate been below the levels implied by the Taylor rule for most of the period since the early 2000s in both advanced and emerging market economies. This finding suggests that monetary policy has probably been systematically accommodative for most of the past decade. The deviation may, however, in part also reflect lower levels of equilibrium real interest rates that might introduce an upward bias in the traditional Taylor rule.
We study the cross-border impact of quantitative easing (QE) in the major advanced economies, especially on emerging market economies. We first examine the cross-border financial market impact of central bank announcements of asset purchase programmes. We find marked QE announcement effects on global financial markets. Quantitative easing influenced prices of a broad range of emerging market assets, raising equity prices, lowering government and corporate bond yields and compressing CDS spreads. The evidence supports the view that QE programmes in advanced economies influenced market expectations about the strength of cross-border financial flows to emerging market economies and about accommodative monetary policy responses of emerging market central banks to concerns about these capital flows. In other words, the announcement of QE measures in one economy contributed to easier global liquidity conditions through the immediate re-pricing of assets in global financial markets. We then turn to the macroeconomic impact of US quantitative easing on emerging market and advanced economies using a global vector error-correcting model (VECM). In additional to the standard trade channels, this model takes account of financial linkages using the BIS locational bank lending statistics. The size of the estimated international spillover effects differed across regions. First, lower US treasury bond yields raised equity prices significantly in the advanced economies, but the expansionary impact on growth and inflation was only about half of that on the US economy. Second, there was little evidence that lower yields in the United States led to rapid credit growth in other advanced economies, at least in the immediate aftermath of the crisis. Third, the impact on emerging economies was in general stronger than that on the other advanced economies. In some economies such as Hong Kong and Brazil, the expansionary impact of US quantitative easing was significant and associated with rapid credit growth and strong capital inflow, currency appreciation and inflationary pressures.Full publication: Are Central Bank Balance Sheets in Asia Too Large?
The paper provides a survey of fiscal and monetary policies during the 1930s under the Hoover and Roosevelt Administrations and how they influenced the policies during the recent Great Recession. The discussion of the causal impacts of monetary policy focuses on papers written in the last decade and the findings of scholars using dynamic structural general equilibrium modeling. The discussion of fiscal policy shows why economists do not see the New Deal as a Keynesian stimulus, describes the significant shift toward excise taxation during the 1930s, and surveys estimates of the impact of federal spending on local economies. The paper concludes with discussion of the lessons for the present from 1930s monetary and fiscal policy.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
Although bank supervision under the National Banking System exercised a light hand and panics were frequent, depositor losses were minimal. Double liability induced shareholders to carefully monitor bank managers and voluntarily liquidate banks early if they appeared to be in trouble. Inducing more disclosure, marking assets to market, and ensuring prompt closure of insolvent national banks, the Comptroller of the Currency reinforced market discipline. The arrival of the Federal Reserve weakened this regime. Monetary policy decisions conflicted with the goal of financial stability and created moral hazard. The appearance of the Fed as an additional supervisor led to more “competition in laxity” among regulators and “regulatory arbitrage” by banks. When the Great Depression hit, policy-induced deflation and asset price volatility were misdiagnosed as failures of competition and market valuation. In response, the New Deal shifted to a regime of discretion-based supervision with forbearance.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
Scholars differ on whether central bank intervention mitigates banking panics. In April 1929, a fruit fly infestation in Florida forced the U.S. government to quarantine fruit shipments from the state and destroy infested groves. In July, depositors panicked in Tampa and surrounding cities. The Federal Reserve Bank of Atlanta rushed currency to member banks beset by runs. We show that this intervention arrested the panic and estimate that bank failures would have been twice as high without the Federal Reserve’s intervention. Our results suggest that similar interventions may have reduced bank failures during the Great Depression.
Over the last quarter century, the U.S. economy has faced a number of financial shocks originating in a variety of sectors and locations around the globe. While most of these crises have had little or no effect on the United States, the recent financial crisis caused the worst U.S. recession since the Great Depression. ; The causes of these crises are varied. To some extent, however, a buildup of financial imbalances preceded each crisis. In some cases, asset prices rose to unsustainable levels inconsistent with market fundamentals. In other cases, a buildup of foreign debt precipitated a currency crisis. A key question for policymakers is whether policy actions taken in the period leading up to the crisis leaned against, or contributed to, the building imbalances. ; Kahn explores whether policy actions taken in the period leading up to the recent financial crisis inadvertently exacerbated financial imbalances by keeping policy-controlled interest rates too low for too long. He uses deviations from Taylor rules as indicators of interest rates being held too low and considers a number of indicators of financial imbalances. While there appears to be a statistically significant relationship between Taylor rule deviations and a number of financial indicators, their economic significance is mixed.
This paper addresses the question of whether and how easy monetary policy may lead to excesses in financial and real asset markets and ultimately result in financial dislocation. It presents evidence suggesting that periods when short-term interest rates were persistently and significantly below what Taylor rules would prescribe are correlated with increases in asset prices, especially as regards housing, though no systematic effects are identified on equity markets. Significant asset price increases, however, can also occur when interest rates are in line with Taylor rules, possibly associated with periods of financial deregulation and/or innovation. Finding also some support for a link of countries' pre-crisis monetary stance with the extent to which their financial sectors were hit during the recent crisis, the paper argues that accommodating monetary policy over the period 2002-2005, probably in combination with rapid financial market innovation, would, in retrospect, seem to have been among the factors behind the run-up in asset prices and financial imbalances - the (partial) unwinding of which helped trigger the recent financial market crisis. --
We estimate a forward-looking monetary policy reaction function for the postwar United States economy, before and after Volcker's
appointment as Fed Chairman in 1979. Our results point to substantial differences in the estimated rule across periods. In
particular, interest rate policy in the Volcker-Greenspan period appears to have been much more sensitive to changes in expected
inflation than in the pre-Volcker period. We then compare some of the implications of the estimated rules for the equilibrium
properties of inflation and output, using a simple macroeconomic model, and show that the Volcker-Greenspan rule is stabilizing.
More than any of his predecessors in the White House, Franklin D. Roosevelt drew heavily on the thinking of economists as he sought to combat the Great Depression, to mobilize the American economy for war, and to chart a new order for the post-war world. Designs Within Disorder, published in 1996, is an inquiry into the way divergent analytic perspectives competed for official favour and the manner in which the President opted to pick and choose among them when formulating economic policies. During the Roosevelt years, two 'revolutions' were underway simultaneously. One of them involved a fundamental restructuring of the American economy and of the role government was to play in it. A second was an intellectual revolution which engaged economists in reconceptualizing the nature of their discipline. Most of the programmatic initiatives Roosevelt put in place displayed a remarkable staying power for over half a century.
Today, most scholars agree that mismanaged monetary policy contributed to the length and severity of the Great Depression in the USA. There is little agreement, however, about the causes of the Federal Reserve's mistakes. This book examines the policy strategy developed by the Federal Reserve during the 1920s and considers whether its continued use could explain the Federal Reserve's failure to respond vigorously to the depression. It also studies the effects on policy of the institutional changes occurring prior to the depression. While these changes enhanced the authority of officials who opposed open-market purchases and also caused some upward bias in discount rates, Wheelock concludes that monetary policy during the depression was in fact largely a continuation of the previous policy. The apparent contrast in the institution's responsiveness to economic conditions between the 1920s and early 1930s resulted from the consistent use of a procyclical policy strategy that caused it to respond more vigorously to minor recessions than to severe depressions.
Was clearinghouse membership a key factor mitigating withdrawals from intermediaries during the Panic of 1907? Analyzing balance-sheet information on institutions in New York and Chicago, we find evidence that clearinghouse members had smaller contractions in demand deposits than did nonmembers. New York City trusts, isolated from the clearinghouse, were subject to heightened perceptions of risk, and suffered large-scale withdrawals because they were outside of the clearinghouse and therefore much less prepared to withstand large-scale depositor runs. We suggest that this aspect of the Panic of 1907 helped to forge support for the creation of a U.S. central bank.
Many economists are accustomed to thinking about Federal Reserve policy in terms of the institution's "dual mandate," which refers to price stability and high employment, and in which the exchange rate and other international variables matter only insofar as they influence inflation and the output gap -- which is to say, not very much. In fact, this conventional view is heavily shaped by the distinctive and peculiar circumstances of the last three decades, when the influence of international considerations on Fed policy has been limited. In fact, the Federal Reserve paid significant attention to international considerations in its first two decades, followed by relative inattention to such factors in the two-plus decades that followed, then back to renewed attention to international aspects of monetary policy in the 1960s, before the recent period of benign neglect of the international dimension. I argue that in the next few decades, international aspects are likely to play a larger role in Federal Reserve policy making than at present.
Introduction, 19. — I. The theory of interest rate structure, 19. — II. Origin and evolution of the rate structure, 27. —
III. Effects of maintenance of the yield pattern, 27. — IV. Significance to credit policy of maintaining the yield structure,
36. — V. Conclusions for policy, 40. — VI. Interest rate structures and compensatory open market operations, 41.
Using an event study approach, we find the announcement by the Bank of France in 1907 to accelerate gold payments directly for U.S. crops is associated with the ultimate upturn in U.S. equity prices. Spillover to the French financial markets accompanied the Regents’ decision to release sterilized reserves, thereby arresting the drainage of coin in French circulation. Counterfactual analysis shows that the facility alone would have been unlikely to end the crisis. Investors may have revised equity expectations upward, recognizing that the acceleration in reliable seasonal gold flows would relieve monetary stringency.
This paper considers the use of new Keynesian open economy models to evaluate monetary policy rules. While recognizing the importance policy evaluation with such models, it presents a number of criticisms about assumptions relating to wage determination, the real interest rate, divine coincidence and financial stability.
This paper develops a method to identify asset price booms, focused on housing, stock markets and commodities, with data from 18 OECD countries from 1920 onwards. It checks whether boom episodes can be linked to various measures of monetary policy, namely deviations from the Taylor rule and a money growth rate. The results show that a "lax" monetary policy-in which the interest rate is below the target or the growth rate of the money base exceeds the target rate-does have a positive impact on asset prices, and that this correspondence is exacerbated in periods of sharp price increases, and then suffer a significant correction, this result being robust. Another finding is that low inflation and, to a lesser extent, "easy" credit, are also associated with asset price increases".
This paper reviews and interprets some of the key policy implications that flow from a class of DSGE models for optimal monetary policy in the open economy. The framework suggests that good macroeconomic outcomes in open economies are possible by focusing inflation targeting that is implemented by a Taylor type rule, a rule that in equilibrium is reflected in the exchange rate as an asset price. Optimal monetary policy will not be able deliver a stationary (‘stable’) nominal exchange rate – let alone a fixed exchange rate or one that remains inside a target zone ‐ because, absent a commitment device, optimal monetary can’t deliver a stationary domestic price level. Another feature in the data for inflation targeting countries that is consistent with monetary policy via Taylor type rule is that it will tend push the nominal exchange rate in the opposite direction from PPP in response to an ‘inflation’ shock – the ‘bad news god news’ result of Clarida –Waldman (2008;2014). This is so even though in the long run of these models the nominal exchange rate must in expectation obey PPP.
Between 2002 and 2006, the Federal Reserve set interest rates significantly below the rates suggested by well-known monetary policy rules. There is a growing body of research suggesting that this helped fuel an excess of liquidity in the U.S. that contributed to the 2008 worldwide financial crash. It is less well known that a number of other central banks also lowered interest rates during this period. An important question, then, is what role the Federal Reserve played in influencing other central banks to alter their own monetary policies, which could have magnified the Fed’s actions in creating global liquidity. This paper addresses the issue by showing how spillovers in central bank behavior occur in theoretical rational expectations models. It then establishes empirically how U.S. monetary policy actions affect the actions of other major central banks, particularly in terms of interest rates and currency interventions. The models and data suggest that the U.S. lowering its policy rate, either in general or in reference to a monetary policy rule, influences other central banks to lower their own policy rates and intervene in currency markets, even when controlling for worldwide macroeconomic trends. It thus appears that U.S. actions were a factor in the worldwide lowering of interest rates and the increase in currency reserves in the early 2000s that may have contributed to the subsequent global liquidity boom.
This is the sixth of a series of papers that are being written as part of a project to estimate a small quarterly Global Projection Model (GPM). The GPM project is designed to improve the toolkit to which economists have access for studying both own-country and cross-country linkages. In this paper, we add three more regions and make a number of other changes to a previously estimated small quarterly projection model of the US, euro area, and Japanese economies. The model is estimated with Bayesian techniques, which provide a very efficient way of imposing restrictions to produce both plausible dynamics and sensible forecasting properties.
Research in the early 1980s found that the gains from international coordination of monetary policy were quantitatively small compared to simply getting domestic policy right. That prediction turned out to be a pretty good description of monetary policy in the 1980s, 1990s, and until recently. Because this balanced international picture has largely disappeared, the 1980s view about monetary policy coordination needs to be reexamined. The source of the problem is not that the models or the theory are wrong. Rather there was a deviation from the rule-like monetary policies that worked well in the 1980s and 1990s, and this deviation helped break down the international monetary balance. There were similar deviations at many central banks, an apparent spillover culminating in a global great deviation. The purpose of this paper is to examine the possible causes and consequences of these spillovers, and to show that uncoordinated responses of central banks to the deviations can create an amplification mechanism which might be overcome by some form of policy coordination.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
In this article we develop new tools to survey the development of lending‐of‐last‐resort operations in the mid‐nineteenth century. One finding is that free lending and extensive liquidity support against good collateral developed gradually after 1847, and was already a fact of life before Bagehot published Lombard Street. Another is that the extension of the Bank of England's lender‐of‐last‐resort function went along with a reduction of its exposure to default risks, in contrast with accounts that have associated lending of last resort with moral hazard. Finally, we provide a new interpretation of the ‘high rates’ advocated by Bagehot. We suggest they were meant to prevent banks from free‐riding on the safety offered by the central bank, and were aimed at forcing them to keep lending during crises so as to maintain a critical degree of liquidity in the money market.
This paper considers why political leaders and central bankers continued to adhere to the gold standard as the Great Depression intensified. We do not focus on the effects of the gold standard on the Depression, which have been documented elsewhere, but on the reasons why policy makers chose the policies they did. We argue that the mentality of the gold standard was pervasive and compelling to the leaders of the interwar economy. It was expressed and reinforced by the discourse among these leaders. It was opposed and finally defeated by mass politics, but only after the interaction of national policies had drawn the world into the Great Depression.
This paper examines what we have learned and how we should change our thinking about monetary policy strategy in the aftermath of the 2007-2009 financial crisis. It starts with a discussion of where the science of monetary policy was before the crisis and how central banks viewed monetary policy strategy. It will then examine how the crisis has changed the thinking of both macro/monetary economists and central bankers. Finally, it looks how much of the science of monetary policy needs to be altered and draws implications for monetary policy strategy.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
Given in Leicester on Tuesday 14 October.
In the aftermath of the global financial crisis, the state of macroeconomic modeling and the use of macroeconomic models in policy analysis has come under heavy criticism. Macroeconomists in academia and policy institutions have been blamed for relying too much on a particular class of macroeconomic models. This paper proposes a comparative approach to macroeconomic policy analysis that is open to competing modeling paradigms. Macroeconomic model comparison projects have helped produce some very influential insights such as the Taylor rule. However, they have been infrequent and costly, because they require the input of many teams of researchers and multiple meetings to obtain a limited set of comparative findings. This paper provides a new approach that enables individual researchers to conduct model comparisons easily, frequently, at low cost and on a large scale. Using this approach a model archive is built that includes many well-known empirically estimated models that may be used for quantitative analysis of monetary and fiscal stabilization policies. A computational platform is created that allows straightforward comparisons of models’ implications. Its application is illustrated by comparing different monetary and fiscal policies across selected models. Researchers can easily include new models in the data base and compare the effects of novel extensions to established benchmarks thereby fostering a comparative instead of insular approach to model development.
Global current account imbalances have been at the forefront of policy debates over the past few years. Many observers have recently singled them out as a key factor contributing to the global financial crisis. Current account surpluses in several emerging market economies are said to have helped fuel the credit booms and risk-taking in the major advanced deficit countries at the core of the crisis, by putting significant downward pressure on world interest rates and/or by simply financing the booms in those countries (the "excess saving" view). We argue that this perspective on global imbalances bears reconsideration. We highlight two conceptual problems: (i) drawing inferences about a country's cross-border financing activity based on observations of net capital flows; and (ii) explaining market interest rates through the saving-investment framework. We trace the shortcomings of this perspective to a failure to consider the distinguishing characteristics of a monetary economy. We conjecture that the main contributing factor to the financial crisis was not "excess saving" but the "excess elasticity" of the international monetary and financial system: the monetary and financial regimes in place failed to restrain the build-up of unsustainable credit and asset price booms ("financial imbalances"). Credit creation, a defining feature of a monetary economy, plays a key role in this story.
Most central banks perceive a trade-off between stabilizing inflation and stabilizing the gap between output and desired output. However, the standard new Keynesian framework implies no such trade-off. In that framework, stabilizing inflation is equivalent to stabilizing the welfare-relevant output gap. In this paper, we argue that this property of the new Keynesian framework, which we call the divine coincidence, is due to a special feature of the model: the absence of nontrivial real imperfections. We focus on one such real imperfection, namely, real wage rigidities. When the baseline new Keynesian model is extended to allow for real wage rigidities, the divine coincidence disappears, and central banks indeed face a trade-off between stabilizing inflation and stabilizing the welfare-relevant output gap. We show that not only does the extended model have more realistic normative implications, but it also has appealing positive properties. In particular, it provides a natural interpretation for the dynamic inflation–unemployment relation found in the data.
The evolution of “a marvel of modern finance,” the market for U.S. Treasury securities, from 1917 to 1939.
The market for U.S. Treasury securities is a marvel of modern finance. In 2009 the Treasury auctioned 1 billion of interest-bearing Treasury debt outstanding, spread out over just six issues. New offerings were rare, and the debt was narrowly held, most of it owned by national banks. In Birth of a Market, Kenneth Garbade traces the development of the Treasury market from a financial backwater in the years before World War I to a multibillion dollar market on the eve of World War II.
Garbade focuses on Treasury debt management policies, describing the origins of several pillars of modern Treasury practice, including “regular and predictable” auction offerings and the integration of debt and cash management. He recounts the actions of Secretaries of the Treasury, from William McAdoo in the Wilson administration to Henry Morgenthau in the Roosevelt administration, and their responses to economic conditions. Garbade's account covers the Treasury market in the two decades before World War I, how the Treasury financed the Great War, how it managed the postwar refinancing and paydowns, and how it financed the chronic deficits of the Great Depression. He concludes with an examination of aspects of modern Treasury debt management that grew out of developments from 1917 to 1939.
Since December 2008, the Federal Reserve’s traditional policy instrument, the target federal funds rate, has been effectively at its lower bound of zero. In order to further ease the stance of monetary policy as the economic outlook deteriorated, the Federal Reserve purchased substantial quantities of assets with medium and long maturities. In this paper, we explain how these purchases were implemented and discuss the mechanisms through which they can affect the economy. We present evidence that the purchases led to economically meaningful and long-lasting reductions in longer-term interest rates on a range of securities, including securities that were not included in the purchase programs. These reductions in interest rates primarily reflect lower risk premiums, including term premiums, rather than lower expectations of future short-term interest rates.
Early in 1932 the Federal Reserve System made a serious attempt to reverse the “Great Contraction” throught expansionary open market operations, but abandoned it a few months later. In this paper we offer an interpretation of the episode that throws new light on the Fed's behavior during the Depression. Key are the attitude of private bankers, Britain's abandonment of the gold standard, and the brief open market campaign. To protect bank profits the Fed abandoned the program which set the stage for the complete financial collapse of the United States in early 1933.
Details the evolution of the monetary standard from the start of the Federal Reserve through the end of the Greenspan era. The book places that evolution in the context of the intellectual and political environment of the time. By understanding the fitful process of replacing a gold standard with a paper money standard, the conduct of monetary policy becomes a series of experiments useful for understanding the fundamental issues concerning money and prices. How did the recurrent monetary instability of the 20th century relate to the economic instability and to the associated political and social turbulence? After the detour in policy represented by FOMC chairmen Arthur Burns and G. William Miller, Paul Volcker and Alan Greenspan established the monetary standard originally foreshadowed by William McChesney Martin, who became chairman in 1951. The Monetary Policy of the Federal Reserve explains in a straightforward way the emergence and nature of the modern, inflation-targeting central bank.
A series of recent reviews of the depression of 1920–1921 by Austrian School and libertarian economists have argued that the
downturn demonstrates the poverty of Keynesian policy recommendations. However, these writers misrepresent important characteristics
of the 1920–1921 downturn, understating the actions of the Federal Reserve and overestimating the relevance of the Harding
administration’s fiscal policy. They also engage a caricatured version of Keynesian theory and policy, which ignores Keynes’s
views on the efficacy of nominal wage reductions and the preconditions for monetary and fiscal intervention. This paper argues
that the government’s response to the 1920–1921 depression was consistent with Keynesian recommendations. It offers suggestions
for when Austrian School and Keynesian economics share common ground and argues that the two schools come into conflict primarily
in downturns where nominal interest rates are low and demand is depressed. Neither of these conditions held true in the 1920–1921
depression.
KeywordsMacroeconomics–Economic history–Keynesianism–Austrian School–Monetary policy–Fiscal policy
We study the international monetary policy design problem within an optimizing two-country sticky price model, where each country faces a short run tradeoff between output and inflation. The model is sufficiently tractable to solve analytically. We find that in the Nash equilibrium, the policy problem for each central bank is isomorphic to the one it would face if it were a closed economy. Gains from cooperation arise, however, that stem from the impact of foreign economic activity on the domestic marginal cost of production. While under Nash central banks need only adjust the interest rate in response to domestic inflation, under cooperation they should respond to foreign inflation as well. In either scenario, flexible exchange rates are desirable.
This study compares the out-of-sample forecasting accuracy of various structural and time series exchange rate models. We find that a random walk model performs as well as any estimated model at one to twelve month horizons for the dollar/pound, dollar/mark, dollar/yen and trade-weighted dollar exchange rates. The candidate structural models include the flexible-price (Frenkel-Bilson) and sticky-price (Dornbusch-Frankel) monetary models, and a sticky-price model which incorporates the current account (Hooper-Morton). The structural models perform poorly despite the fact that we base their forecasts on actual realized values of future explanatory variables.
This paper reports estimates of monetary policy reaction functions for two sets of countries: the G3 (Germany, Japan, and the US) and the E3 (UK, France, and Italy). We find that since 1979 each of the G3 central banks has pursued an implicit form of inflation targeting, which may account for the broad success of monetary policy in those countries over this time period. The evidence also suggests that these central banks have been forward looking: they respond to anticipated inflation as opposed to lagged inflation. As for the E3, even prior to the emergence of the `hard ERM', the E3 central banks were heavily influenced by German monetary policy. Further, using the Bundesbank's policy rule as a benchmark, we find that at the time of the EMS collapse, interest rates in each of the E3 countries were much higher than domestic macroeconomic conditions warranted. Taken all together, the results lend support to the view that some form of inflation targeting may be superior to fixing exchange rates, as a means to gain a nominal anchor for monetary policy.
The paper examines international issues that arise in the design and evaluation of macroeconomic policy rules. It begins with a theoretical investigation of the effects of fiscal and monetary policy in a two-country rational expectations model with staggered wage and price setting and with perfect capital mobility. The results indicate that with the appropriate choice of policies and with flexible exchange rates, demand shocks need not give rise to international externalities or coordination issues. Price shocks, however, do create an externality, and this is the focus of the empirical part of the paper. Using a simple seven-country model — consisting of Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States — optimal cooperative and non-cooperative (Nash) policy rules to minimize the variance of output and inflation in each country are calculated. The cooperative policies are computed using standard dynamic stochastic programming techniques and the non-cooperative policies are computed using an algorithm developed by Finn Kydland. The central result is that the cooperative policy rules for these countries are more accommodative to inflation than the non-cooperative policy rules.
We construct estimates of external assets and liabilities for 145 countries for 1970–2004. We describe our estimation methods and key features of the data at the country and global level. We focus on trends in net and gross external positions, and the composition of international portfolios. We document the increasing importance of equity financing and the improvement in the external position for emerging markets, and the differing pace of financial integration between advanced and developing economies. We also show the existence of a global discrepancy between estimated foreign assets and liabilities, and identify the asset categories accounting for this discrepancy.
The paper suggests an alternative framework to test hypotheses about central bank policy rules during the International Gold Standard. This framework is inspired by work of Mundell (1968) on optimal central bank policies, and more recent literature on the theory of economic policy, which stems from Luca's (1976) critique. Empirical tests obtained from this approach are quite different from those appearing in the empirical literature on the Gold Standard.The results of the tests indicate that the Bank of England was not optimally targeting international gold flows. Inthe case of the Rechsbank, the hyphothesis that international gold flows were optimally targeted is not rejected at the 5 per level. Thus the data suggest that the Reichsbank was following the ‘rules of the game’, whereas the Bank of England was not.
We examine the quantitative impact of the Federal Reserve’s mortgage-backed securities (MBS) purchase program. We focus on how much of the recent decline in mortgage interest rate spreads can be attributed to these purchases. The question is more difficult than frequently perceived because of simultaneous changes in prepayment and default risks. When we control for these risks, we find evidence of statistically insignificant or small effects of the program. For specifications where the existence or announcement of the program appears to have lowered spreads, we find no separate effect of the size of the stock of MBS purchased by the Fed.
The demise of sterling as an international currency was widely predicted after 1945, but the process took thirty years to complete. Why was this demise so prolonged? Traditional explanations emphasize British efforts to prolong sterling’s role because it increased the capacity to borrow, enhanced prestige, or supported London as a centre for international finance. This book challenges this view by arguing that sterling’s international role was prolonged by the weakness of the international monetary system and by collective global interest in its continuation. Using the archives of Britain’s partners in Europe, the USA and the Commonwealth, Catherine Schenk shows how the UK was able to convince other governments that sterling’s international role was critical for the stability of the international economy and thereby attract considerable support to manage its retreat. This revised view has important implications for current debates over the future of the U.S. dollar as an international currency.
Staggered wage contracts as short as 1 year are shown to be capable of generating the type of unemployment persistence which has been observed during postwar business cycles in the United States. A contract multiplier causes business cycles to persist beyond the length of the longest contract, and a diffusion of shocks across contracts causes the persistence to increase for several periods before diminishing. A persistence of inflation is also generated by the contracts. This persistence is represented as a reduced-form distributed-lag wage equation in which the lag coefficients have a pure-expectations component and an inertia component due to the overhang of outstanding contracts. Using rational expectations to separate these components suggests that aggregate demand may have a greater impact on inflation than the simple reduced-form estimates would indicate.