Friday, November 2, 2012

Dave Altig: Has Fed Behavior Changed?

I never thought I would be reporting regression results in public, let alone having people comment on those results. Life is full of surprises. Dave Altig has written a response to this blog post.

1. Dave points out that, given my crappy model, the current fed funds rate is well within a standard error of a predicted value of 1.1%. I am of course no Taylor rule fanatic, and am willing to blame Taylor for any shortcomings of his rule. Dave could also have pointed out that the relevant policy rate is the interest rate on reserves, which is the overnight nominal rate of return faced by most of the financial institutions in the system. The current fed funds rate is only relevant to the GSEs, who now do most of the lending in the fed funds market. 0.25% is even closer to 1.1% than the current fed funds rate, which makes Altig's case stronger. But hold on. Given past behavior, the FOMC should at least be considering that they will be increasing the policy rate soon. But they are promising to keep it where it is until mid-2015. Seems like a break with previous behavior, don't you think?

2. Here's Dave's dual mandate analogy:
Consider a homeowner with the dual mandate of keeping both the roof of the house and the driveway in good repair. If the roof isn't leaking but there are cracks in the driveway, I think you would expect to see the owner out on the weekend patching the concrete. I don't think you would conclude as a result that he or she had ceased caring as much about the condition of the roof. I do think you would conclude that attention is being focused where the problem exists.
I see it more like this. Suppose the homeowner has a husband. The dual mandate is: Keep the roof in good repair, and make sure the husband behaves well. Keeping the roof in good repair is a task with a well-defined goal, and the homeowner knows how to do it. Getting the husband to behave well is ill-defined, and at best the homeowner knows that she can only move him temporarily toward what she might see as well-behaved. She would be foolish to think otherwise.


  1. or how about given unconventional tools currently in use, the estimated fed funds rate is somewhere around -2 to -2.5% right now.. at least that was the intention of the Fed as per their own papers.

  2. Yes, that was the argument that was being used to promote QE. Taylor rules were predicting negative fed funds rates which, it was argued, meant the Fed needed to do something else. They have done a huge amount of the something else, which by their logic implies a much more accommodative policy. There's the forward guidance as well, as I mentioned above.