Edward M Gramlich: The Board's modeling work in the 1960s
Remarks by Mr Edward M Gramlich, Member of the Board of Governors of the US Federal Reserve
System, at the Federal Reserve Board Models and Monetary Policy Conference, Washington, DC,
26 March 2004.
* * *
I am delighted to be speaking at a conference honoring Dale Henderson, Dick Porter, and Peter
Tinsley. I remember all of them from long ago. Peter and I joined the Board staff in September 1965,
when Pat Hendershott and Bob Parry also joined. At least in terms of longevity, that was a pretty
significant hiring month. I remember being on a panel with Dick at an academic conference in those
days. He had not yet joined the Board, being an assistant professor at Ohio State. Being thoroughly a
Michigan man now, I probably should not admit it, but I also met him, along with Dave Lindsey, when I
interviewed for a job at Ohio State. The job interview didn't pan out, I think mainly on my side but
perhaps on theirs too.
I also knew Dale back then. He joined the Board shortly after I left, but I met him socially in the early
1970s. Frankly, I still remember one thing he said to me. When I mentioned that I used to be on the
Board's staff, he said he knew - he had read some of my stuff. "Well," I said expectantly. "Oh, some of
it's OK," he said. With his subsequent international exposure, Dale has gotten much more diplomatic
over the years.
All three principals have made great contributions to economic modeling at the Board. Peter started
with optimal control techniques and distributed lags, and continued with rational expectations
estimation procedures. Dick's work focused on money demand and monetary control techniques. Dale
was instrumental in developing the Board's global model. All three have generally promoted research
at the Board, helped younger scholars get established, sponsored working paper series, and fought
for better computers and other support.
As for the models themselves, the topic of the conference, I feel like Rip Van Winkle. In the very early
days, 1965-70, I was here and indeed right in the middle of the producer side of the model work. Then
I went off and did other things for twenty-seven years, returning in 1997 as a consumer of models.
Things changed a lot in those twenty-seven years.
Most of you are reasonably familiar with what the model looks like now. But apart from the real
graybeards, the three principals and I, most of you were probably in grade school when this work
actually started. Let me recall a few stories from the old days.
The main motivator at the Board in those days was Frank de Leeuw. For all who knew Frank, he was
one of the most "market undervalued" economists of all time. All the young people at the Fed then felt
he walked on water. Frank formed a team of economists here - Tinsley, Hendershott, Al Tella, and me
among others - and an academic team featuring the late Franco Modigliani from MIT and the late
Albert Ando from Penn. Bob Rasche, now research director at the St. Louis Fed, and Harold Shapiro,
later to be my university president at Michigan, were also junior professors at Penn and part of the
team. Jerry Enzler, whom many of you remember fondly, as I do, was somewhere in transition,
starting as a Penn graduate student and moving to the Board staff, where he too stayed many years.
The model we put together in those days has been enshrined in publications and I won't describe it
much. It probably had about the coverage of the present day FRBUS, and it had many of the then
exotic channels of monetary policy. There was a consumption-wealth effect working through equity
values and housing values, and both of those prices were endogenous. At one point, Franco got one
of his graduate students, a lively kid named Larry Meyer, to do his thesis on this link. There was a
foreign sector, but exchange rates were exogenous because we had pegged rates back then. There
was also a credit-rationing channel based largely on the work of another Franco graduate student,
Dwight Jaffee, who is now an authority on government-sponsored enterprises at Berkeley.
What we didn't have in those days was forward-looking expectations behavior. In qualitative terms we
all knew the difference between adaptive and rational expectations, but nobody knew how to estimate
rational expectations equations. This is one area where technical work over the years has made a
large difference, and I gather that several people in the room, especially Peter Tinsley, have been
responsible. In more immediate terms, the aspect of the model that still recalls frustration was that
whenever we ran dynamic full-model simulations, the simulations would blow up. I can't tell you how
many hours Jerry Enzler and I spent feeding in our regression cards, and our simulation cards, to work
on this issue. Yes, we fed in punch cards in those days. Nowadays when Board economists present
the results of dynamic simulations in briefings, and the simulations look very reasonable, I think I am
one of the few people in the room who is deeply impressed.
Doctrinal historians will have fun with the naming of this model. Whenever Board people wrote about
it, it was the Fed-MIT model, or perhaps the Fed-MIT-Penn model. When Ando wrote it became the
MPS model - MIT-Penn-Social Science Research Council model. All the Social Science Research
Council did was to give Ando a grant. And where was the Fed? We did do a lot of the early work on
the model.
A number of people have raised questions about monetary and fiscal policy itself in the 1960s - how
could policy have been so misguided? First off, let me say that the modeling group was quite aware of
the natural rate hypothesis then. We knew that an adaptive expectations Phillips Curve would explode
if the lag coefficient was one - we just couldn't get its estimated value to be one. We had yet to apply
Kalman filters or other split-sample techniques and were yet to realize the problems with the sum of
the lagged coefficients test. But even apart from lag effects, as papers by Bill Poole (another Division
of Research and Statistics staff member from those days), George de Menil (another Franco student),
and Jerry Enzler show, our nonlinear Phillips Curves became very, very steep at low unemployment
rates, implying that inflation would become uncontrollable at low unemployment rates.
On the point Athanasios Orphanides raises about the value of the natural rate, we probably were
wrong about that. I remember being stunned by a Bob Hall paper in the 1970s that placed the natural
rate at about 5 percent. By the way, in the mid-1970s Franco began calling this rate NIRU, and later
Jim Tobin, I think, switched it over to NAIRU.
But the main problems with policy in those days were, um, with the policymakers. First off, presidential
interference on discount rate policy got the discount rate set below the funds rate in 1965, a problem
we never fixed until two years ago. I think this artificially low discount rate may have held down the
funds rate, leading to the overly expansionary monetary policy amply documented by John Taylor. It
was obvious to virtually all economists that the country needed a permanent budget shift as Vietnam
spending increased, but what came out of that was a delayed temporary tax increase. Anything else
would have made the war less popular, and by then the Vietnam War was pretty darn unpopular. Quite
possibly, our intellectual understanding was not where it should have been in the late 1960s, but
90 percent of the policy problems were political, with the policymakers themselves.
These days the Board staff makes a baseline forecast and grafts on FRBUS to get the results for
alternative scenarios. We actually began to do these types of experiments once our model was put
together in the late 1960s. I was dying to present the results to the Board, but never could get past
Lyle Gramley, our sponsor but also our gatekeeper. He didn't trust the model enough when it was
used as a pure forecasting device. Then, as I suppose now, we had the most trouble forecasting
equipment investment - most of the other final demand sectors worked pretty well. The investment
accelerator was also the reason our dynamic simulations ran off-track. When we would suspend the
investment equation, things would work reasonably well. I have heard the modern day staff complain
about estimating an accelerator effect for equipment and software and, believe me, I am sympathetic.
Another place where the intervening years have made a real difference is the way in which the
baseline forecast itself was put together. In our day it was totally anticipations data - leading indicators
of this or that, for a quarter or two ahead at most. Today I hear Dave Stockton describe the baseline
forecast in very model-oriented terms - this effect, that coefficient, and so forth. Nowadays the
baseline forecast also runs out a few years, something the judgmental forecasters of earlier days
would never have attempted, and it even has measures of forecast uncertainty. All of these are real
improvements, far beyond what was done in the 1960s.
For me, this work all came to an end in May 1970. At the time I felt we had brought the model as far as
I thought we could bring it, at least for a while, and I really wanted to do some other kind of economics.
Whether the external pastures were in fact greener I will never know - they just seemed greener at the
time. So I left the Board staff, confident that I would never return either to the Board or to large-scale
macro modeling. But sure enough, there were some other twists of fate and here I am, back, as a
model consumer. And, I think, an ideal consumer because I realize how hard it is to do this kind of
work.