The Reserve Bank of New Zealand released a paper by Nicolas Groshenny last month—I’m behind on planning for Chanukkah; that I got to a paper from New Zealand about U.S. monetary policy this soon is, er, probably one of the reasons why—in which he evaluates the counterfactual of following the “Taylor Rule” from 2002 to 2006.
Groshenny finds (link is PDF):
[T]his paper estimates a New Keynesian model with unemployment and performs a counterfactual experiment where monetary policy strictly follows a Taylor rule over the period 2002:Q1 – 2006:Q4. The paper finds that such a policy would have generated a sizeable increase in unemployment and resulted in an undesirably low rate of inflation. Around mid-2004, when the counterfactual deviates the most from the actual series, the model indicates that the probability of an unemployment rate greater than 8 percent would have been as high as 80 percent, while the probability of an inflation rate above 1 percent would have been close to zero.
Several obvious questions:
- The period in question includes Alan Greenspan’s last hurrah as Chair of the FRB. If he had followed the Taylor Rule then, would his legacy be so fondly remembered by his champions?
- If the Taylor Rule would have done that much damage then, why is it getting such vehement advocacy now (with only Scott Sumner—whose model has the virtue of being consistent—throwing out cautionary notes from the conservative side)?*
- Is the NAIRU for post-2001 U.S. U-3 closer to 8% than anyone in their right mind currently believes?
- Most of the period covered by the paper is when we had a, uh, relatively inexperienced crony capitalist running the U.S. Treasury Department. How much cover should that give to the FRB?
I’m certain there are other, better questions. Feel free to mention them below. And, while we’re at it, let’s see if we can answer the question of why 8% unemployment with less than a 1% inflation rate was unaccepted to the Bush-Cheney Administration but is perfectly fine with the Summers/Geithner “Rubinites“-with-Obama crowd.
*I’m still trying to figure out if Andy Harless is on Sumner’s side or playing both sides against a middle that may not exist, but I suspect he should be included in Sumner’s camp.