Evolving views on monetary policy in the thought of Hayek,Friedman, and Buchanan

Attempting to find the technically optimal monetary policy is futile if the Federal Reserve’s independence is undermined by political influences. F. A. Hayek, Milton Friedman, and James Buchanan each sought ways to improve the performance of the Federal Reserve. They each ended up rejecting the possibility that technical refinement or minor reforms might be sufficient. After properly accounting for the concerns of robust political economy, each concluded that a fundamental restructuring of our monetary system was necessary. Friedman turned to binding rules, Buchanan to constitutionalism, and Hayek to competing private currencies. We synthesize their contributions to make a case for applying the concepts of robust political economy to the Federal Reserve through the adoption of professional humility, creative thinking, and an emphasis on the politically possible, not the politically acceptable.     

Transparent US monetary policy: theory and tests

In 1994, the Federal Reserve System moved to a more transparent reporting of monetary policy. This article assesses the impact of monetary policy transparency on uncertainty about future monetary policy using T-bill rate forecast dispersions and ex post forecast errors from the Survey of Professional Forecasters as a proxy for monetary policy uncertainty. The empirical findings confirm that Federal Reserve transparency has reduced the uncertainty about future monetary policy.     

OUTSIDE INFLUENCES ON MONETARY POLICY: A SUMMARY OF RECENT FINDINGS

This paper reports on a program that begun in 1985 to research political and private pressures on monetary policy. The program developed a number of measures of outside pressures on monetary policy, identified the time periods and circumstances under which the Federal Reserve was responsive to these measures, and indicated how different classes of Fed officials responded to certain of these pressures. Initial findings appear in a number of journal articles from 1987 to 1992. Havrilesky (1993) extends and refines these findings by employing new and larger data sets. Subsequent articles amplify the findings by estimating monetary policy reaction functions that specifically introduce outside influences together with state-of-the-economy measures as explanatory variables .     

DO POLITICS CAUSE REGIME SHIFTS IN MONETARY POLICY?

Whether or not politics cause changes in monetary policy is controversial in the literature. This article re‐examines the link between politics and regime shifts in monetary policy using two alternative approaches. First, empirical results show that both the presidential and Federal Reserve Bank (Fed) chairmanship regimes do not influence monetary policy under the assumption that the Fed closely follows an interest rate rule. On the other hand, evidence also suggests that changes in political regimes are able to account for the deviations from the optimal Taylor rule. (JEL E52, E58, D78)     

A MANDATE OF PRICE STABILITY FOR THE FEDERAL RESERVE SYSTEM

In recent years, the rules-versus-discretion debate over monetary policy has taken on new life. In the 1960s, this debate focused on the relative merits of nonactivist policies versus activist stabilization policies. When rational expectations arguments emerged in the 1970s, the debate broadened into three categories: activist policies characterized by rules, activist policies characterized by discretion, and nonactivist policies characterized by rules. This paper presents arguments for a particular example of the latter of these policies…specifically, a monetary policy which accords preeminence to achieving price-level stability. Central to these arguments is a comparison of this hypothetical policy with the actual monetary policy pursued by the Federal Reserve System, which is a type of activist policy characterized by discretion. The comparison suggests that actual monetary policy is more constrained than is generally realized. A rule mandating that the Federal Reserve accord preeminence to achieving price-level stability, then, should not be regarded as a policy which would significantly increase constraints on monetary policy. Instead, such a rule should be regarded as replacing implicit, poorly understood constraints with explicit constraints.     

The powers that are: central bank independence in the Greenspan era

This paper investigates political pressure from incumbent Presidents and Congress on US monetary policy during the period that Greenspan was the chairman of the Federal Reserve. We propose an expectations-augmented Taylor rule in which we replace realized values with expectations, and use the unemployment gap instead of the output gap. We apply a state-space framework that allows the use of mixed frequency data. Our findings suggest that the Federal Reserve under Greenspan did not create election driven cycles, but also did not strictly follow the Taylor rule. The deviations from the Taylor rule are not driven by partisan politics, but are rooted in the expected economic conditions.     

Optimal versus realized policy rules in a regime-switching framework

In this paper we compare a deterministic model and a Markov switching model to analyze the behavior of the US economy and the Federal Reserve. We examine both optimal and empirical monetary policies for the US Federal Reserve between 1960 and 2008. We compare the optimal monetary policy to the actual interest rates and to the empirical reaction function. We also evaluate the sensitivity of the results to the preferences assigned to each objective. We find that there is no unique optimal solution that fits the Federal Reserve behavior over the entire period. The best fit to the actual interest rates is obtained by an optimal policy with preference switches following the rule: a high-volatility regime coincides with a priority on inflation alone while in a low-volatility regime there is equal policy priority on output stabilization and inflation.     

THE FED AND THE POLITICAL BUSINESS CYCLE

This study asks whether the Federal Reserve has actively made monetary policy so as to aid the president's reelection. Using Shiller's smoothness "prior" to estimate the shape of cycles, the study finds a political business cycle in unemployment and a preelection increase in growth of the money supply. But the timing of these two cycles is inconsistent. Furthermore, little evidence exists of a cycle in the instruments of monetary policy. Thus, the Fed is not actively creating a political business cycle. Apparently, movements in real money that are not caused—but are not offset—by the Fed are an important cause of the political business cycle.
Elections influence Fed behavior. Monetary tightness occurs early in a presidential term, before reelection incentives become critical. This is due to the Fed's political weakness. Thus, the Fed's independence only partly insulates it from electoral pressures.     

THE FED AND THE POLITICAL BUSINESS CYCLE

This study asks whether the Federal Reserve has actively made monetary policy so as to aid the president's reelection. Using Shiller's smoothness "prior" to estimate the shape of cycles, the study finds a political business cycle in unemployment and a preelection increase in growth of the money supply. But the timing of these two cycles is inconsistent. Furthermore, little evidence exists of a cycle in the instruments of monetary policy. Thus, the Fed is not actively creating a political business cycle. Apparently, movements in real money that are not caused—but are not offset—by the Fed are an important cause of the political business cycle.
Elections influence Fed behavior. Monetary tightness occurs early in a presidential term, before reelection incentives become critical. This is due to the Fed's political weakness. Thus, the Fed's independence only partly insulates it from electoral pressures.     

Interest on reserves,settlement, and the effectiveness of monetary policy

Over the last several years, the Federal Reserve has conducted a series of large scale asset purchases. The effectiveness of these purchases is dependent on the monetary transmission mechanism. Former Federal Reserve chairman Ben Bernanke argued that large scale asset purchases are effective because they induce portfolio reallocations that ultimately lead to changes in economic activity. Despite these claims, a large fraction of the expansion of the monetary base is held as excess reserves by commercial banks. Concurrent with the large scale asset purchases, the Federal Reserve began paying interest on reserves and enacted changes in its Payment System Risk policy. In this paper, I estimate the effect of the payment of interest on reserves (as well as other payment policy changes) on the demand for daylight overdrafts through Fedwire. Since Fedwire provides overdrafts at a fixed price, any fluctuation in the quantity of overdrafts is a change in demand. A reduction in overdrafts corresponds with an increase in the demand for reserves. I show that the payment of interest on reserves has had a negative and statistically significant effect on daylight overdrafts. Furthermore, I interpret these results in light of recent theoretical work. I argue that by paying an interest rate on excess reserves that is higher than comparable short term rates, the Federal Reserve likely hindered the portfolio reallocation channel outlined by Bernanke. Thus, the payment of interest on reserves increased payment processing efficiency, potentially at the expense of limiting the ability of monetary policy to influence economic activity.     

Distorting taxes and interest on reserves

Few governments in developed economies currently pay interest on reserves. However, Goodfriend (2001) [Goodfriend, M., 2001. Interest on reserves and monetary policy, mimeo, Federal Reserve Bank of Richmond] concludes that it is a useful tool to implement monetary policy. In a monetary growth model with a financial intermediary and a firm who needs to borrow to pay wages, it is shown that paying interest on reserves financed by a labor tax reduces welfare.     

Unconventional monetary policy,liquidity trap,and asset prices

This article offers a fundamental critique of monetary policy implemented in the United States following the 2007–8 global financial crisis. It aims to show that the misunderstanding of the mainstream theoretical thinking underlying monetary policy actions led to the ineffectiveness of the policy response to the 2007–8 global financial crisis. The conventional view that monetary policy is the stabilization tool has serious flaws and is ineffective for bringing about economic recovery. The Federal Reserve’s experiment with the so-called unconventional monetary policy exposed the weakness of the conventional belief in understanding how banks operate, how the monetary authority can influence the yield curve, and how the monetary transmission mechanism works, resulting in prescribing an ineffective treatment to boost economic activity. In this regard, it is argued that the Federal Reserve’s decision to let long-term interest rates be market determined represents a significant self-imposed constraint, which limits policy options regarding monetary policy actions and the effective control of long-term interest rates. By limiting the setting of policy rates only to the overnight interest rate, the ability of the monetary authority to influence long-term interest rates is both weak and indirect.     

The depression of 1920–1921: a credit induced boom and a market based recovery?

This paper examines the American post-WW1 boom and bust. It argues that the Federal Reserve’s monetary easing from 1919 to 1920 created an Austrian Business Cycle (ABC), or an unsustainable credit boom. The collapse of the boom initiated the Depression of 1920–1921. The subsequent laissez faire policy promoted a swift recovery. In particular, the natural recovery began following a severe liquidation of firms, reallocation of resources, and wage cuts stimulated by fiscal and monetary contraction. Contrary to some other accounts, we find that significant recovery began before the Federal Reserve’s 1921–1922 monetary easing affected the economy. We also address other criticisms of the credit-cycle interpretation.     

Taylor rules and the Great Inflation

Can US monetary policy in the 1970s be described by a stabilizing Taylor rule when policy is evaluated with real-time inflation and output gap data? Using economic research on the full employment level of unemployment and the natural rate of unemployment published between 1970 and 1977 to construct real-time output gap measures for periods of peak unemployment, we find that the Federal Reserve did not follow a Taylor rule if appropriate measures are used. We estimate Taylor rules and find no evidence that monetary policy stabilized inflation, even allowing for changes in the inflation target. While monetary policy was stabilizing with respect to inflation forecasts, the forecasts systematically under-predicted inflation following the 1970s recessions and this does not constitute evidence of stabilizing policy. We also find that the Federal Reserve responded too strongly to negative output gaps.     

THE IMPACT OF A NEW FEDERAL RESERVE CHAIRMAN

This paper treats appointing a Federal Reserve Chairman as a portfolio investment made by the United States President. It models Ronald Reagan's 1987 choice between Paul Volcker and other candidates as a trade-off between a potentially unfavorable short-term market response to replacing Volcker and various long-term political benefits from installing Reagan's own man. The paper discusses possible effects of Alan Greenspan's chairmanship on the trajectory of future monetary policy, on the Fed's preferences for financial reform, and on the Fed's corporate culture.     

The Policy Anticipation Hypothesis: Evidence from the Federal Funds Futures Market

In an era of increasingly transparent policy making by the Federal Reserve, market participants appear to interpret each economic announcement based on the implication for monetary policy. As a result, when macroeconomic news arrives economic agents revise their expectations of upcoming policy decisions and interest rates move accordingly. This article provides empirical support for this policy anticipation hypothesis utilizing the Federal funds futures market to proxy for policy expectations. The results indicate that once one controls for the role of policy anticipation the impact of many announcements on bond yields becomes statistically insignificant. (JEL E4 , E5 , G1 )     

美联储应对金融危机的货币政策操作与效果

美国次贷危机发生后,银行体系遭受重创,信贷活动萎缩,市场利率上升,实体经济难以得到资金支持,美国经济陷入了衰退。为了刺激经济复苏,稳定金融市场,修复银行体系,美联储密集地进行货币政策操作,通过各种方式向市场注入流动性。本文对2007年以来美联储所采取的货币政策加以梳理,对其影响进行分析,并提出我国的应对之策。     

Monetary policy and long-term US interest rates

This paper assesses the effect of federal funds rate innovations on longer-term US nominal interest rates across different periods. The evidence suggests that these responses change with changes in the monetary policy regime. Time periods considered are pre- and post-1979 and different Federal Reserve Chairman’s tenure. The response of longer-term interest rates to federal funds rate innovations are shown to be smaller and less persistent in the post-1979 period when the Federal Reserve placed more emphasis on inflation.     

Does Partisan Heritage Matter? The Case of the Federal Reserve

Received evidence suggests that changes in appointer- and overseer-preferencesinfluence monetary policy (i.e., partisan heritage matters).Evidence presented here, on the other hand, is consistent withchanges in the cost of pursuing a common preference influencingpolicy. I draw this evidence from a panel of Federal Open MarketCommittee (FOMC) votes and find support for the following conclusions:(1) Federal Reserve Board (FRB) governors who were nominatedand confirmed by the same party (Republican or Democrat) prefersignificantly looser policy than do other FOMC members. (2)Monetary policy is significantly looser when either party controlsthe oversight mechanism (i.e., the presidency and Senate) thanwhen control is split. (3) Oversight acts less forcefully ondistrict bank presidents than on FRB governors. In short, thepresent evidence suggests that political agents from both partiesprefer loose money and pursue this preference more efficientlywhen their parties are aligned.     

An alternative monetary policy target

For most of the period since the mid-1970s, the Federal Reserve has expressed its monetary policy intentions by announcing the target growth rates of three principal monetary aggregates: the simple-sum M1, M2 and M3. However, the sweeping changes and the deregulation in the financial industry have greatly affected the relevance of these traditional monetary aggregates. The unusual behaviour of the simple-sum monetary aggregates has forced the Federal Reserve to stop setting target range for M1. The measuring of monetary aggregates has become a controversial question. This paper constructs the new-benchmark Divisia monetary indexes which reflect ‘moneyness’ more accurately than the old Divisia indexes. I demonstrate that the historical trends of the Divisia monetary indexes are sensitive to the brenchmark rates chosen in constructing these indexes. In addition, I compare the forecasting performance of the new-benchmark Divisia monetary indexes with the simple-sum and the old Divisia monetary indexes in the estimated money demand functions. I find that the new-benchmark Divisia monetary indexes provide the best statis forecasting performance. The result indicate that the new-benchmark Divisia monetary indexes should be considered as alternative measures of money in studying the relationship between money and the economy.