Empirically Evaluating Economic Policy in Real Time

John B. Taylor

The Martin Feldstein LectureNational Bureau of Economic Research

July 10, 2009

The Purpose of Today’s Feldstein Lecture

• To evaluate macroeconomic policy during the crisis, focusing on the period since the panic in the fall 2008 by comparing actual policy with counterfactuals:– About monetary policy– About fiscal policy• Each counterfactual is composed of several sub-

counterfactuals• “Real time” because the crisis is ongoing

Why the Emphasis on “Real Time”?

• The financial crisis has made it essential – You have to evaluate policy quickly to be helpful

• Interesting: loads of new data and new policies• Raises new questions about the use of high

frequency data and simulation techniques• It really is different

How is it different?• Most macro-money research not done in real time

– Taylor (1979): • fixed growth rate rule would work better than actual policy but

not as good as optimal policy: 1953-75– Feldstein and Stock (1997):

• evaluated policy rules for M2: 1959-92– Cecchetti, Flores-Lagunes, Krause (2006):

• Has Monetary Policy Become More Efficient? 24 countries: 1982-1998

– Bernanke (2005) • Analysis of Great Moderation: pre and post 1984

• A recent exception – Lars Svensson (2009):

• modified Taylor Curve based on forecasts• Evaluates Riksbank policy: February 2009

The Counterfactuals

Figure 1 from Taylor (1979)

Figure 1 from Bernanke (2005), “The Great Moderation”

Figure 3. The modified Taylor curve

Figure 3 from Svensson (2009) “Evaluating Monetary Policy”

Four Phases of the Crisis

• The Root Causes – 2003-2006– The Great Deviation?

• From Flare-up to Panic: Aug 2007- Sept 2008– The Great Delay?

• Panic of Sept 2008– The Great Scare?

• Post Panic Period: Sept 2008- present

The Focus of this Lecture

The Panic of Fall ‘08

The Panic of Fall ‘08

Actual Monetary Policy Since the Panic of 2008

• During the week of 17 Sept 2008, reserve balances rose, for the first time, above the level required to keep the federal funds rate on target, which was then 2% – Quantitative easing (QE) began before the funds rate hit 0– Reserves were increased to finance loans, first to

investment banks through PDCF, and to purchase securities

– Reserves were not increased to accommodate a shift in money demand, or a decline in velocity

• Reserves then continued to increase through end of 08 – To finance additional securities purchases and loans– Drove interest rate to zero , which FOMC then ratified– Have remained elevated and are expected to increase

0

200

400

600

800

1,000

2005 2006 2007 2008 2009

Reserve Balances of

Depository Institutions at

Federal Reserve Banks

Billions of dollars

September 10, 2008$ 8 Billion

December 31, 2008$ 848 Billion

0

200

400

600

800

1,0003

0 J

UL

13

AU

G

27

AU

G

10

SE

P

24

SE

P

08

OC

T

22

OC

T

05

NO

V

19

NO

V

03

DE

C

17

DE

C

31

DE

C

14

JA

N

28

JA

N

11

FE

B

25

FE

B

11

MA

R

25

MA

R

08

AP

R

22

AP

R

06

MA

Y

20

MA

Y

03

JU

N

17

JU

N

Weekly AverageWednesday Level

Billions of dollars

400

800

1,200

1,600

2,000

2,400

30

JU

L

13

AU

G

27

AU

G

10

SE

P

24

SE

P

08

OC

T

22

OC

T

05

NO

V

19

NO

V

03

DE

C

17

DE

C

31

DE

C

14

JA

N

28

JA

N

11

FE

B

25

FE

B

11

MA

R

25

MA

R

08

AP

R

22

AP

R

06

MA

Y

20

MA

Y

03

JU

N

17

JU

N

SecuritiesReposLoans from TAFOther loansPrivate PortfolioCB Liquidity SwapOther Assets

Billions of dollars

Major Factors Supplying Reserves

0

100

200

300

400

500

600

700

800

900

30

JU

L

13

AU

G

27

AU

G

10

SE

P

24

SE

P

08

OC

T

22

OC

T

05

NO

V

19

NO

V

03

DE

C

17

DE

C

31

DE

C

14

JA

N

28

JA

N

11

FE

B

25

FE

B

11

MA

R

25

MA

R

08

AP

R

22

AP

R

06

MA

Y

20

MA

Y

03

JU

N

17

JU

N

Commercial Paper Funding FacilityMaiden Lane I (Bear Stearns)Maiden Lane II (AIG)Maiden Lane III (AIG)Mortgage Backed SecuritiesGSE Debt

Billions of dollars

Private Portfolio

0

200

400

600

800

1,000

0.0

0.5

1.0

1.5

2.0

2.5

30 J

ul6

Aug

13 A

ug20

Aug

27 A

ug3

Sep

10 S

ep17

Sep

24 S

ep1

Oct

8 O

ct15

Oct

22 O

ct29

Oct

5 N

ov12

Nov

19 N

ov26

Nov

3 D

ec10

Dec

17 D

ec24

Dec

31 D

ec

billionsof dollars

percent

Reserve Balances(left scale)

Effective Federal Funds Rate(right scale)

Timing of FOMC Decisions: Fall 2008• 10/8: FOMC votes to cut funds rate to 1.5 % from 2.0 %

– But for the 2 weeks ending Oct 8, the funds rate was already well below 2.0 %, averaging 1.45 %

• 10/29: FOMC votes to cut funds rate to 1 % from 1.5% – But for the 2 weeks ending Oct 29, the funds rate was

already well below 1.5 %, averaging .76 % • 12/16: FOMC votes to cut funds rate to 0-.25% from 1%

– But for the 2 weeks ending Dec 17, the rate was already in that range, averaging .14 %

• Thus, decisions to increase reserve balances drove down the funds rate rather than the FOMC decisions about the target rate.

Choosing a Counterfactual Monetary Policy

• A general counterfactual: When the optimal interest rate (e.g. Taylor rule) hits “zero” (or slightly positive, say .25%)• Trading Desk keeps reserve balances at a level consistent

with .25 % and keeps the growth rate of money from falling– like a CGRR

• This is how quantitative monetary models are usually simulated for policy evaluation. (Wieland presentation yesterday)

• Avoids Great Depression or Japan Lost Decade mistakes where money growth declined

• A more specific counterfactual, closer to actual policy: • MBS = $0 (rather than $500B and rising to $1,200B) • TAF = $0 (rather than as much as $500B), • Purchases of LT Treasuries = $0 (rather than up $300B)

0

200

400

600

800

1,000

2005 2006 2007 2008 2009

Reserve Balances of

Depository Institutions at

Federal Reserve Banks

Billions of dollars

September 10, 2008$ 8 Billion

December 31, 2008$ 848 Billion

0

200

400

600

800

1,000

2005 2006 2007 2008 2009

Counterfactual Reserve Balances of

Depository Institutions at

Federal Reserve Banks

Billions of dollars

September 10, 2008$ 8 Billion

0

200

400

600

800

1,0003

0 J

UL

13

AU

G

27

AU

G

10

SE

P

24

SE

P

08

OC

T

22

OC

T

05

NO

V

19

NO

V

03

DE

C

17

DE

C

31

DE

C

14

JA

N

28

JA

N

11

FE

B

25

FE

B

11

MA

R

25

MA

R

08

AP

R

22

AP

R

06

MA

Y

20

MA

Y

03

JU

N

17

JU

N

Weekly AverageWednesday Level

Billions of dollars

0

200

400

600

800

1,0003

0 J

UL

13

AU

G

27

AU

G

10

SE

P

24

SE

P

08

OC

T

22

OC

T

05

NO

V

19

NO

V

03

DE

C

17

DE

C

31

DE

C

14

JA

N

28

JA

N

11

FE

B

25

FE

B

11

MA

R

25

MA

R

08

AP

R

22

AP

R

06

MA

Y

20

MA

Y

03

JU

N

17

JU

N

Counterfactual Weekly Average

Billions of dollars

400

800

1,200

1,600

2,000

2,400

30

JU

L

13

AU

G

27

AU

G

10

SE

P

24

SE

P

08

OC

T

22

OC

T

05

NO

V

19

NO

V

03

DE

C

17

DE

C

31

DE

C

14

JA

N

28

JA

N

11

FE

B

25

FE

B

11

MA

R

25

MA

R

08

AP

R

22

AP

R

06

MA

Y

20

MA

Y

03

JU

N

17

JU

N

SecuritiesReposLoans from TAFOther loansPrivate PortfolioCB Liquidity SwapOther Assets

Billions of dollars

Major Factors Supplying Reserves

400

800

1,200

1,600

2,000

2,400

30

JU

L

13

AU

G

27

AU

G

10

SE

P

24

SE

P

08

OC

T

22

OC

T

05

NO

V

19

NO

V

03

DE

C

17

DE

C

31

DE

C

14

JA

N

28

JA

N

11

FE

B

25

FE

B

11

MA

R

25

MA

R

08

AP

R

22

AP

R

06

MA

Y

20

MA

Y

03

JU

N

17

JU

N

CF SecuritiesReposOther loansCF Private PortfolioCB Liquidity SwapOther Assets

Billions of dollars

Major Factors Supplying Reserves

0

100

200

300

400

500

600

700

800

9003

0 J

UL

13

AU

G

27

AU

G

10

SE

P

24

SE

P

08

OC

T

22

OC

T

05

NO

V

19

NO

V

03

DE

C

17

DE

C

31

DE

C

14

JA

N

28

JA

N

11

FE

B

25

FE

B

11

MA

R

25

MA

R

08

AP

R

22

AP

R

06

MA

Y

20

MA

Y

03

JU

N

17

JU

N

Commercial Paper Funding FacilityMaiden Lane I (Bear Stearns)Maiden Lane II (AIG)Maiden Lane III (AIG)Mortgage Backed SecuritiesGSE Debt

Billions of dollars

Private Portfolio

0

100

200

300

400

500

600

700

800

9003

0 J

UL

13

AU

G

27

AU

G

10

SE

P

24

SE

P

08

OC

T

22

OC

T

05

NO

V

19

NO

V

03

DE

C

17

DE

C

31

DE

C

14

JA

N

28

JA

N

11

FE

B

25

FE

B

11

MA

R

25

MA

R

08

AP

R

22

AP

R

06

MA

Y

20

MA

Y

03

JU

N

17

JU

N

Commercial Paper Funding FacilityMaiden Lane I (Bear Stearns)Maiden Lane II (AIG)Maiden Lane III (AIG)GSE Debt

Billions of dollars

Counterfactual Private Portfolio

140

160

180

200

220

240

260

280

300

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09

30 year fixed mortgage rateminus 10 year Treasuries

Basis points

0

100,000

200,000

300,000

400,000

500,000

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09

Millions of dollars

Fed purchases of MBS

0

20

40

60

80

100

120

140

160

07M01 07M07 08M01 08M07 09M01 09M07

CDS on FNMA Bonds

Basis Points

Spread: FNMA Bonds - Treasuries

140

160

180

200

220

240

260

280

300

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09

Basis Points

30 year fixed mortgage rateminus 10 year Treasuries

with MBSpurchases

withoutMBS purchases

0

1

2

3

4

5

0

100

200

300

400

500

600

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09

Term Auction Facility(right scale)

Lois

Libor-repo

PercentBillions of dollars

0

50,000

100,000

150,000

200,000

2.0

2.5

3.0

3.5

4.0

4.5

Oct 08 Jan 09 Apr 09

Ten Year Treasury Yield(right axis)

Millions of Dollars

Cumulative Fed Purchasesof Long Term Treasuries(left axis)

Percent

What About Fiscal Policy?

• What should be the counterfactual? – Only the automatic stabilizers?

• No stimulus package in 2008? • No stimulus package in 2009?

• Still too early for 2009, but here is a preliminary look…

9,200

9,600

10,000

10,400

10,800

11,200

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09

Personal consumptionexpenditures

Disposable personalincome

without stimulus package

Billions of dollars

Here We Go Again?

Deficit, Federal Government Purchases, and Transfers to State and Local Governments for Purchases of Goods and Services in

the February 2009 Stimulus Legislation (billions of dollars)

Fiscal Increase Increase Increase Year in Federal in Transfers to in

FederalPurchases States, Localities Deficit

2009 21 48 1842010 47 107 4002011 46 47 1342012 36 8 362013 25 4 271014 27 0 222015 11 0 52016 -2 0 -82017 -3 0 -72018 -2 0 -6

Table 3 from Cogan, Cwik, Taylor, Wieland (2009)

What about government purchases?

New Keynesian Estimate of Impact of Government Purchases

G is about as forecast by CCTW in Q1 and Q2

-.4

-.2

.0

.2

.4

.6

.8

2009 2010 2011 2012 2013

Government purchases (G)

Consumption (C)

Investment (I)

C plus I

Percent of GDP

Conclusion• The financial crisis demonstrates the need for

real time policy evaluation.– Fast-moving events, unprecedented policy responses– 24 hr news cycle, blogs, quick spread of 1st idea– Good policy depends on it – Will not end with the crisis

• We now can collect and process data rapidly. – No reason to wait 30 years as Friedman/Schwartz

• Can do better:– More higher-frequency data (eg. Diebold)– Improved techniques (eg. Svensson)– Better outlets (Journal of Real Time Policy Evaluation)