John Cochrane recently responded on his blog to the news that Congress were going to debate that the Fed be required by legislation to choose a monetary policy rule, and stick to it, justifying when and why it departs from it.
His post surprised me somewhat. It seemed relatively favourable to the idea. Not entirely convinced. But raising practical questions like: what would go in the rule, what would be left out? What about macroprudential policy? Putting on the table the distinction between instrument rules [schemes that stipulate directly what should be done with the interest rate] and targeting rules [jargon to describe schemes for evaluating the outcomes of policy, where the policymaker is left to decide how best to do its job].
Cochrane has written quite a lot that bears on how much weight we should put on the literature that extols the benefits of Taylor-like rules in the sticky-price macro model.
One theme, in his Journal of Political Economy paper, is: the benefits claimed for rules like the Taylor Rule are much less reliable than you might think, because they are based on arbitrary and very unconvincing procedures for picking out one particular equilibrium in the sticky price model from the many possible.
Another theme, that he has developed in his blog, focuses on policy recommendations for escaping the zero bound that emerge from the sticky price model. The basic idea is: at the zero bound, the sticky price model throws up some mighty strange results. Rather than forcefully recommending the prescriptions that rely on them, these strange results should cause us to wonder whether the model isn’t itself wrong.
Key prescriptions are that the central bank should engage in forward guidance, lowering the future rate when it can’t push today’s interest rate any lower. And implementing a fiscal stimulus on the basis that the multiplier is so large in these models when monetary policy is stuck at the ZLB.
The results that Cochrane [rightly in my view] says are weird, are what protagonists have dubbed the ‘paradoxes’. Like the paradox that if you reduce potential output, by destroying capital, or force workers to work part-time, you can increase inflationary pressure, so much so that the economy escapes the zero bound and output increases. [There are other exotic results too, like the fact that if you fix interest rates for protracted periods, these models can go from generating huge inflations to huge deflations as you extend the period of fixed rates out just one more quarter].
So, to recap, I was expecting John Cochrane to say that it was way too early to start legislating on the basis of a literature that used dodgy logic to select equilibria, and threw up so many paradoxes at the zero bound. [And I would have agreed with him].