Recent Developments in Monetary Macroeconomics
Altig, David, Journal of Money, Credit & Banking
THE CONTENTS OF THIS VOLUME hardly require explanation beyond its title: "Recent Developments in Monetary Macroeconomics." Our intent for the conference was to collect a set of papers reflecting the cutting edge of applied monetary macroeconomics. As befitting such an ambitious-sounding goal, the contributions are wide ranging. For purposes of this brief introduction, however, we might organize the papers as answers to three questions. (1) What is the "optimal" Taylor rule? (2) Are "New Keynesian" or "New Neoclassical Synthesis" models the final word on the monetary transmission mechanism? (3) Is there a role for money in the conduct of monetary policy?
WHAT IS THE "OPTIMAL" TAYLOR RULE
The inclusion of the Taylor rule issue is almost a prerequisite for any collection of papers purporting to survey recent developments in monetary macroeconomics. In policy discussions, the Taylor rule is ubiquitous, and it is currently the choice among alternative specifications of central bank behavior. More precisely, perhaps, the general form of the Taylor rule is the choice, as it has come to represent the general class of equations that relate the federal funds rate to some measure of an output gap and inflation rate. There is substantially less unanimity about whether output gaps and inflation rates should be past, present, or (expected) future values, whether past values of the funds rate need to be included, and what are the appropriate magnitudes of the responses to each of these measures.
Marc Giannoni and Michael Woodford offer the natural approach to addressing the dispute: find the representation that is optimal within the framework being employed for policy analysis. The model in question here is essentially a derivative of the "New Neoclassical Synthesis" class of models that are currently the workhorses of most monetary policy analyses among academic and central bank staffs alike. Their approach to discovering the optimal policy within this structure has the flavor of the "Ramsey problem" familiar from optimal tax policy, although with the strong requirement that the derived policy rule be "robustly optimal": it must support the optimal equilibrium no matter what the distribution of disturbances the model policymakers face.
Giannoni and Woodford offer two essential lessons. First, whether optimal policy incorporates forecasts of future price-level growth or output gaps depend critically on the dynamics of the inflation rate. If the adjustment of the price-level to shocks is inertial, then optimal policy necessarily depends on forecasts of future inflation. Second, the response of the funds rate to its own past is inertial. In fact, it is super-inertial, meaning that (all else equal), the contemporaneous funds rate responds more than one-for-one with the lagged value of the funds rate (and lagged changes in the rate).
The proposition that monetary authorities ought to aggressively respond to lagged values of the funds rate also arises in the papers by Jess Benhabib, Stephanie Schmitt-Grohe, and Martin Uribe, and George Evans and Seppo Honkapohja. In the latter case, the authors consolidate and expand on their well-known work on learning dynamics. A central contribution of the work presented in this article is the notion that convergence to a unique rational expectations equilibrium under learning, as well as the stability of that equilibrium, serves as basis for the choice (or rejection) of an optimal policy formulation.
An apparent lesson from Evans and Honkapohja's analysis is that the learnability criterion prescribes a policy rule that differs in some important ways from the conventional wisdom coming from analyses that invoke the Taylor rule in a pure rational expectations environment. In particular, they conclude that the optimal policy rule in the environment they consider requires the monetary authority to respond directly to private-sector expectations. …