mr. meyer examines the role for structural macroeconomic models in the monetary policy process remarks by mr. laurence h. meyer, a member of the board of governors of the us federal reserve system, at the aea panel on monetary and fiscal policy held in new orleans on 5 / 1 / 97. the role for structural macroeconomic models i am in the middle of my third interesting and active encounter with the development and / or use of macroeconometric models for forecasting and policy analysis. my journey began at mit as a research assistant to professors franco modigiliani and albert ando during the period of development of the mps model, continued at laurence h. meyer & associates with the development of the washington university macro model under the direction of my partner, joel prakken, and the use of that model for both forecasting and policy analysis, and now has taken me to the board of governors where macro models have long played an important role in forecasting and policy analysis and the mps model has recently been replaced by the frb - us model. i bring to this panel a perspective shaped by both my earlier experience and my new responsibilities. i will focus my presentation on the role of structural macro models in the monetary policy process, compare the use of models at the board with their use at laurence h. meyer & associates, and discuss how the recently introduced innovations in the federal reserve model might further advance the usefulness of models in the monetary policy process. i. structural models and monetary policy analysis i want to focus on three contributions of models to the monetary policy process : as an input to the forecast process ; as a vehicle for analyzing alternative scenarios ; and a vehicle for developing a strategy for implementing monetary policy that disciplines the juggling of multiple objectives and ensures a bridge from short - run policy to long - run objectives. 1. the forecast context for monetary policy decisions because monetary policy has the ability to adjust quickly to changing economic conditions and because lags in the response to monetary policy make it important that monetary policy be forward - looking, monetary policy is very much influenced both by incoming data and by forecasts of spending and price developments. forecasts are central to monetary policy setting. models make a valuable contribution to forecasting. therefore, models can make an important contribution to the setting of monetary policy. models capture historical regularities, identify key assumptions that must be made to condition the forecast, embody estimates of the effects of past and future policy actions on the economy, and provide a

and why we maintained a historically low federal funds rate so long after the trough. just how aggressive was this response, relative to history? in general, comparing monetary policy responses across cyclical episodes is difficult. the natural indicator to look at, the federal funds rate, is measured in nominal terms, so that large movements in the rate of inflation can mask the underlying stance of policy. moreover, an easing of a certain size might be considered relatively more or less aggressive depending on the magnitude and nature of the shocks hitting the economy. still, in the current cycle, the fed began lowering the federal funds rate two months before the official cyclical peak ( as identified by the national bureau of economic research ) and lowered rates 450 basis points over the first year of the easing and 100 basis points over the second year. although this total decline of 550 basis points was not the largest on record, it was large and quite early. and given the relatively small decline in output in 2001, one can easily argue that this monetary policy response was unusually aggressive. similarities with the recovery in the early 1990s in the period since world war ii, several of the earlier recoveries had one or two of these features in common with the most recent period. for example, the rebound in residential investment fell short of the typical burst in 1961, the unemployment rate remained stubbornly high in 1971, and inventory investment remained low in 1975. but no previous recovery looked quite like this one. however, the recovery following the 1990 recession stands out as similar to the current episode in several important respects. first, employment rose at a glacial pace for a year and a half after the trough in early 1991, and the unemployment rate continued to rise. second, the business sector continued for a full year to reduce spending on fixed investment and to refrain from accumulating significant amounts of inventories. third, household spending did not accelerate rapidly after the 1990 recession. instead, both consumption expenditures and residential investment posted among the most - subdued recoveries in the past fifty years. one should note, however, that household expenditures did fall markedly during the 1990 recession, unlike the most recent episode. figuring out why these two recoveries were atypically hesitant and jobless is not an easy task. let me consider several possible explanations. one explanation for the similarity of the two most recent recoveries may be that both of these lukewarm recoveries followed shallow recessions. the shallowness of the downturns is consistent with the general moderation of the vol