The Taylor Rule and the Current Crisis: A Critique

Transcription

1 The Talor Rule and the Current Crisis: A Critique Presentation prepared for the International Conference The Global Crisis: Contributions to the Critique of Economic Theor and Polic Universit of Siena, Ital, Januar 2010 B Emiliano Brancaccio and Giuseppe Fontana 1

2 Introduction: The origin of the current crisis: A quest for the hol grail? Origin of the Crisis: Conventional arguments: mths or realities? Accommodative ( loose ) monetar polic: the Greenspan put World financial imbalances Misguided under-pricing of risk The Greenspan Put and the Talor Rule Greenspan and Fed polic: From maestro to villain? The New Consensus Macroeconomics (NCM) model Insiders and outsiders criticism of the NCM model Further criticisms A Look-alike Talor Rule The Talor rule and the Solow s model of stationar growth The Talor rule as a positive analsis of the Fed polic A monetar theor of social reproduction (MTSR) interpretation of the Talor Rule Two views of the Talor rule: NCM versus MTSR 2 Conclusions

3 Origin of the Current Crisis Conventional Arguments Accommodative ( loose ) monetar polic: the Greenspan put When a crisis arose the Fed came to the rescue of financial markets b significantl and consistentl lowering the funds rate. World financial imbalances Chronic and persistent trade deficit in the US (but also UK, Ireland and Spain) vis-à-vis chronic and persistent trade surpluses of oil exporting and East Asian countries (e.g. China). Misguided under-pricing of risk Financial investors plaed with fire b being overconfident about the abilit of their mathematical models of measuring and managing risk. 3

4 The main fundamental cause of what happened was the piling up over 10 or 15 ears of eas - too eas - monetar policies, ver large current account imbalances in the United States in particular, matched b large structural surpluses in a number of emerging countries which pegged their currencies to the dollar more or less and therefore injected ver large amounts of liquidit into the sstem. This eas mone, eas credit condition propagated a search for higher ields than those that were offered b ver low interest rates which were associated with this eas monetar polic; financial institutions investors engaged in search of higher ields, therefore paing less attention to the qualit of credits, accepting relativel low spreads for high risks, therefore undermining the fundamental prudence of the banking sstem. This was the basic set of circumstances that led to the present crisis (de Larosière, in House of Lords Report, 2009). 4

5 Global Current Account Balances 5

6 The increasing scale and complexit of the securitised credit market was obvious to individual participants, to regulators and to academic observers. But the predominant assumption was that increased complexit had been matched b the evolution of mathematicall sophisticated and effective techniques for measuring and managing the resulting risks. Central to man of the techniques was the concept of Value-at-Risk (VAR), enabling inferences about forward-looking risk to be drawn from the observation of past patterns of price movement. This technique, developed in the earl 1990s, was not onl accepted as standard across the industr, but adopted b regulators as the basis for calculating trading risk and required capital. The ver complexit of the mathematics used to measure and manage risk, moreover, made it increasingl difficult for top management and boards to assess and exercise judgement over the risks being taken. Mathematical sophistication ended up not containing risk, but providing false assurance that other prima facie indicators of increasing risk (e.g. rapid credit extension and balance sheet growth) could be safel ignored (Turner Review, 2009, p. 22) 6

7 Origin of the Current Crisis Conventional Arguments: Mths or Realities? World financial imbalances What was happening was that foreign nations were buing U.S. and U.K. government securities and that merel meant that whatever happened in the financial markets of the local economies would now going to be transferred immediatel to foreign nations. And now people start talking about decoupling : getting one nation s financial sstem not to affect the other nations financial sstems. It s not a smptom, is a mechanism of contagion (Davidson, 2009). 7

8 Origin of the Current Crisis Conventional Arguments: Mths or Realities? Misguided under-pricing of risk Lack of information or wrong information: would ou doubt what Lehman Brothers or JP Morgan said? Would ou doubt what rating agencies gave AAA rating? The problem is then wrong information due to the conflict of interest in the financial markets, and the lack of regulation of agencies Lack of Regulation: Replacement of the traditional Originate-and-Hold model of bank loans with the modern Originate-and-Distribute model 8

9 The Greenspan Put and the Talor Rule Greenspan and Fed polic: From Maestro to villain of modern monetar polic? The new conventional wisdom! What is the role of a central bank in modern economies? What is the transmission mechanism of monetar polic? Are low interest rates a problem (how and when)? The New Consensus Macroeconomics (NCM) and its monetar polic implications: the Aggregate Demand (AD) channel and the Inflation Expectation (IE) channel of the monetar polic transmission mechanism 9

10 Mr. Talor unequivocall claimed that had the Federal Reserve from kept shortterm interest rates at the levels implied b his Talor Rule, it would have prevented this housing boom and bust. This notion has been cited and repeated so often that it has taken on the aura of conventional wisdom. Alan Greenspan (2009) 10

11 The Greenspan Put and the Talor s Rule... Monetar Polic Rules (Talor Rule) The New Consensus Macroeconomics Model Neoclassical Growth Model 11

12 The New Consensus Macroeconomics (NCM) Model Three-equation (closed econom) Model IS-tpe equation Phillips equation Monetar polic rule Two Transmission Channels Aggregate Demand (AD) channel i r C & I AD Y & UN ( ) π Inflation Expectations (IE) channel

13 13 ( ) ( ) ( ) ( ) ( ) s E i a E a a a t t t t t t t = π ( ) ( ) s b E b b t t t t t = π π π ( ) ( ) c c r i T t = 2 1 * π π

14 Insiders Criticisms of NCM How to transform a fair weather model into a all-season model Posen: rational expectations or adaptive expectations? Blanchard: more realistic analsis of financial markets, labour market, goods market, open econom extensions

15 In the 1980s and into the 1990s, the forward-looking rational-expectations models applied to monetar polic b conservative economists like Robert Barro, Alan Meltzer, and Alex Cukierman showed that whenever an central bank looked the least bit dovish b having too much concern for real output versus inflation goals, inflationar expectations would shoot up with no growth benefit. That characterization turned out to be not just an exaggeration through simplification, it was completel misleading. So ou can have a ver activist monetar polic with respect to stabilizing the real econom - which, frankl, the Bernanke Fed seems to have adopted - without worring that inflation is going to explode b so doing (Posen, 2008, p. 20). 15

16 Outsiders Criticisms of NCM Monetar Polic Unemploment bias Distributional effects Financial instabilit Fiscal Polic Historical heritage Ricardian Equivalence hpothesis Practical / political features

17 Further Criticisms of NCM The Strange Marriage of Kenesian (shortrun) and Neoclassical (long-run) Economics Neoclassical Growth Theor AD has (if an) onl a transitor impact on the degree of utilization of existing productive resources The rate of expansion of productive resources over time is not influenced significantl b AD Kenesian Business Ccle Theor Absence of real balances effect (mone is endogenous) and hence lack of explicit stabilit mechanisms Deliberate polic action of the central bank to steer the current level of output toward the natural/full emploment rate, i.e. the 17 Talor rule as the implicit stabilit mechanism

18 AD AS i : 18

19 Out put Trend Output A Current Output t 0 t 1 Time Infl atio n π 0 π* t 0 t 1 Time Figure 1: Output Loss Associated with Disinflation in a Conventional Inflation Targeting Strateg 19

20 A Look-Alike Talor Rule The logical dependenc of the Talor rule on the equilibrium solution of Solow s model of stationar growth The Greenspan Put and the Talor rule again: it s all about the value of ke parameters! (e.g. Krugman, Meer, Talor) The Talor rule as a positive analsis of the Fed polic and beond A monetar theor of social reproduction (MTSR) interpretation of the Talor Rule 20

21 The Talor Rule, the NCM model and Solow s Model Monetar Polic Rules (Talor Rule) The New Consensus Macroeconomics Model Neoclassical Growth Model 21

22 22 g i g g g r i z k g k sf r k f k r P W k f T n ϕ π π β λ π θ θπ = = = = = = (6) ) ( (5) ) (1 ) ( (4) ) (1 ) ( (3) 1 ) '( (2) ) (1 ) ( (1) 0 *

23 r i g k k f z k k f z r k k k r P W k f γ π γ = = = the sstem is : solvenc of the condition of ) ( 1 ) ( (3') (2') ) (1 ) ( (1')

24 Substituting equations (1') and (3') in the condition of solvenc of the sstem and imposing strict equalit then : (4') k ( W / P) f ( k) i = z r 1 z π k k g 24

25 Two Views of the Talor Rule: NCM vs MTSR (4) i * T = ( r θπ ) (1 θ ) π λg (4') k ( W / P) f ( k) i = z r 1 z π k k g

26 Conclusions The central banker as the implicit stabilit mechanism of the NCM A replacement for the old real balance effect Greenspan versus Talor: it s all about the value of ke parameters (e.g. Krugman, 2009) The central banker as regulator of social conflict for the MTSR Capitalists versus rentiers An alternative interpretation of the origin (and nature) of the current crisis 26

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