Monetaryy Policyy Implications
pof the Global Crisis
John B. TayloryStanford University
Remarks at a panel at theInternational Journal of Central Banking Conference
Hosted by the Bank of Japan
17 Septemberb 2010

Overview• Start from the position that we had a monetary
framework that worked well for years before the crisis.
• Theory: Inflexibilities and policy rules
rules.
– Many examples in Volker Wieland’s model database• Practice: Reasonablyy rules‐based strategy
gy for adjustingjg
money supply and the interest rate.
– Performance was good when policy was close.
– Policy was poor when policy was far away.

• Then monetary policy deviated from this framework.
– Interest rate held too low for too long
– Unorthodox
h d operationsi– Poor performance again• Policyy Implication:
pImplement
pap
policyy like the one thatwas working. To avoid more market disruption,
announce and follow a clear exit rule.

Models in the Wieland Model Database
1.Small Calibrated Models
1.1 Rotemberg, Woodford (1997)
1.2 Levin, Wieland, Williams (2003)
1 3 Clarida
1.3Clarida, Gali,Gali Gertler (1999)
1.4 Clarida, Gali, Gertler 2-Country (2002)
1.5 McCallum, Nelson (1999)
1.6 Ireland (2004)
1.7 Bernanke, Gertler, Gilchrist (1999)
1.8 Gali, Monacelli (2005)

2 Estimated2.
E ti t d US Models
M d l
2.1 Fuhrer, Moore (1995)
2.2 Orphanides, Wieland (1998)
2.3 FRB-US model linearized as in Levin, Wieland, Williams (2003)
2.4 FRB-US model 08 linearized by Brayton and Laubach (2008)
2.5 FRB-US model 08 mixed expectations, linearized by Laubach (2008)
2.6 Smets, Wouters (2007)
2.7 CEE/ACEL Altig, Christiano, Eichenbaum, Linde (2004)
2.8 New Fed US Model by Edge, Kiley, Laforte (2007)
2.9 Rudebusch, Svensson (1999)
2.10 Orphanides (2003b)2.11 IMF projection model by Carabenciov et al. (2008)2.12 De Graeve (2008)
2.13 Christensen, Dib (2008)
2.14 Iacoviello (2005)

3. Estimated Euro Area Models
3.1 Coenen, Wieland (2005) (ta: Taylor-staggered contracts)
3.2 Coenen, Wieland (2005) (fm: Fuhrer-Moore staggered contracts)
3.3 ECB Area Wide model linearized as in Dieppe et al. (2005)
3.4 Smets, Wouters (2003)
3.5. Euro Area Model of Sveriges Riksbank (Adolfson et al. 2007)
3 6 Euro Area Model of the DG-ECFIN EU (Ratto et al.
3.6.
al 2009)
3.7. ECB New-Area Wide Model of Coenen, McAdam, Straub (2008)

4. Estimated Small Open-Economy Models (other countries)
4.1. RAMSES Model of Sveriges Riskbank, Adolfson et al.(2008b)
4.2 Model of the Chilean economy by Medina, Soto (2007)

5. Estimated/Calibrated Multi-Country Models
5.1 Taylor (1993a) model of G7 economies
5.2 Coenen,Wieland (2002, 2003) G3 economies
5.3 IMF model of euro area & CZrep by Laxton, Pesenti (2003)
5.4 FRB-SIGMA model by Erceg, Gust, Guerrieri (2008)

Three Phases of the Crisis: Pre‐Panic, Panic, Post‐Panic
Percent

13 OOctobert b 2008

4.0
3.5

Panic

3.0
25
2.5
2.0
1.5
1.0

Pre‐panic

Post‐panic

9 August 2007

0.50.0
2006

2007

2008

Libor – OIS Spread2009

Before the Panic• Unorthodox
h d measures ddidn’td ’ work;
k some wereharmful.
• Early on
on, TAF did not reduce tension in theinterbank markets; drew attention away fromcounterparty risk.
• The chaotic bailout policy.
– After Bear Sterns, people believed Fed’s balance sheet
would be available in the case of Lehman– But it was turned off.
– Balance sheet then reopened to rescue creditors of AIG.
– Then turned off again and the TARP proposed.

• These unorthodox policies were part of an
unpredictable response to the crisis that led topanic.

During the Panic• Difficult to analyze because unorthodox
measures were intertwined other actions– Such as clarification that the TARP would be used
for equity injections.

• But AMLF and the CPFF were helpfulp restore confidence byy quicklyqy• Also helped
setting up new programs and working closely
p lines.
with other central banks on swap

After the Panic• Unorthodox policies now mainly asset
purchases rather than loans• Biggest was MBS program‐‐$1.25
program $1 25 trillion.
trillion– Without this, balance sheet would be back tonormal.
normal• Stroebel and Taylor find that program hadlittl or no effect…
littleff t

120
80
40
60
040
-40

200-20-40
40
2007

2008

2009

Residuals ((Left Axis))
Swap-OAS (Right Axis)
Predicted Swap-OAS (Right Axis)

Basis points200Basis points

150

80

100

40

5000-40-80
20072008

2009

Residuals (Left Axis)
Treasury-OAS (Right Axis)
Predicted Treasury-OAS (Right Axis)

Treasury OAS

Basis points
200

160

120

Nov 24 (146.5)\Nov 25 (102.6)(102 6)\////

Mar 18 (101.8)/

80

40Jun15

M
ay18A
pr20

M
ar23

Feb
23

Jan
26

Dec

Dec
129

N
ov
30Swap OAS

Basis points
100

Nov 24 (88.7)/
Nov 25 (51.6)
////

80

60

Mar 18 (62.0)/

40200Jun15

M
ay18A
pr20M
ar23Feb23Jan26

Dec

Dec
129

Nov
3-20

It’s Part of a Bigger Problem• AsA ddescribedib d byb Shultz,
Sh lt Boskin,B ki C
Cogan, M
Meltzer,lt
anddTaylor in today’s Wall Street Journal:• “TheThe history of recent economic policy is one ofmassive deviations from basic economic principles.”• “The result has been a crippling recession and now aweak, nearly nonexistent recovery.”• “The deviations began with policies—like the Federal
Reserve holding interest rates too low for too long…
long ”• “The departures from sound principles continued
when the Fed and the Treasury responded with
arbitrary and unpredictable bailouts…”• “The good news is that we can change thesedestructive policies by adopting a strategy based on
proven economic principles. “