Thomas A. LubikFederal Reserve Bank of Richmond

My favorite sentence in the paper is the last:

My favorite sentence in the paper is the last:

“If nothing else, the Bank’s communication approach should make better economists.”

My favorite sentence in the paper is the last:

“If nothing else, the Bank’s communication approach should make better economists.”

This nicely captures the spirit of the paper

But let’s start at the beginning …

OverviewMonetary policy has come a long way:

Not so long ago central banks were very secretive, now they worry about communications strategy

Widespread use of estimated DSGE models

OverviewMonetary policy has come a long way:

Not so long ago central banks were very secretive, now they worry about communications strategy

Widespread use of estimated DSGE models

Driven by intellectual environment:Keynesian aggregate demand thinking is passéMonetary policy has to do with controlling

inflation: Hetzel (2008)

OverviewMuch of the advances in monetary

policymaking pushed by a few SOE central banks: RBNZ: inflation targetingRiksbank: Bayesian DSGE modellingNorges Bank: transparency and

communication

OverviewMuch of the advances in monetary

policymaking pushed by a few SOE central banks: RBNZ: inflation targetingRiksbank: Bayesian DSGE modellingNorges Bank: transparency and communication

Federal Reserve is slowly getting there:Hints of an inflation targetLonger policy projections

April 29 FOMC Statement

“The Committee […] anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

Norges Bank and TransparencyNorges Bank has published model-based

endogenous interest-rate forecasts since November 2005

Transparency strategy includes:Probabilistic statements about future policyExplicit conditioning on shock distributionOpenness about policy maker’s preferences

Key is willingness to put a policy rule on the line:CB reacts to shocks and unforeseen developmentsPolicy response as a general equilibrium outcome

Norges Bank and TransparencyTransparency has arguably been quite

successful:Reduction in interest volatilityMarket expectations close to forecasts

The Costs of TransparencyGoodfriend’s (1986) “Monetary Mystique”Two concerns:

NoiseCommitment to policy path

Theoretical case can be made that a better informed, but secretive trader is beneficial

Concerns that central bank adds noise seem excessive

The Costs of TransparencyMore relevant: public might interpret interest

path as a promise, deviation might be interpreted as discretion

This can be handled by the right communication strategy:Fan chartsInterest rate accountPress conferences

The Interest Rate Account

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08 Q3 09 Q1 09 Q3 10 Q1 10 Q3 11 Q1 11 Q3

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Higher demand in NorwayHigher inflation in NorwayHigher interest rates abroadHigher risk premium in the money marketLower growth abroadChanges in the interest rate path

The Benefits of TransparencyCommitment is more important than

transparencyThere are certainly decreasing returns:

Objective/TargetInstrumentsForecastsPolicy PathsParameter estimates in the DSGE-Model?

In the big scheme of things, the last steps are of second order

The Benefits of TransparencyIs transparency a fair weather issue?Arguably, more open communications in the

last few years gave central banks breathing room to pursue unconventional measures

Transparency does not require the use of a DSGE model

NEMOTypical SOE-DSGE model with the usual bells

and whistlesSmall-scale medium-sized model

NEMOTypical SOE-DSGE model with the usual bells

and whistlesSmall-scale medium-sized modelStriking omission (2006 version): Oil

Oil investmentOil fund distributions as a residual in the

current accountOil producing sector unmodelledRelative price effect on inflation

Oil

Policy PreferencesOptimal policy minimizes ad-hoc loss function

from a “timeless perspective”Where do the weights come from?Why not use Ramsey as the benchmark?

Policy PreferencesOptimal policy minimizes ad-hoc loss function

from a “timeless perspective”Where do the weights come from?Why not use Ramsey as the benchmark?

Key contribution of the micro-foundation approach is not that we have optimization-based decision rules, but that we can talk about the effects of policy on welfare in a meaningful way

Back to the end:

“If nothing else, the Bank’s communication approach should make better economists.”

This guarantees central bank jobs for generations of future PhDs

But there are deeper issues …

Who is the Audience?Public likely to be unimpressed by Bayesian

DSGE modelsPolicymakers are given an additional tool,

competition with other modelsOptimal policy exercises in estimated DSGE

models are a tool to elicit policymaker’s preferences

Monetary Policy as Engineering?DSGE-based approach creates illusion of

controllability

Monetary Policy as Engineering?DSGE-based approach creates illusion of

controllabilityWe’ve been there before:

1972-74 were the heydays of the “large-scale macro- econometric model”

Making policy was simply an optimal control problem

Monetary Policy as Engineering?DSGE-based approach creates illusion of

controllabilityWe’ve been there before:

1972-74 were the heydays of the “large-scale macro- econometric model”

Making policy was simply an optimal control problem

We know how this ended

And arguably no amount of transparency could have prevented this …

Monetary Policy as Engineering!Should not get carried too much away by the

use of DSGE model in the policy processCurrent crop of state-of-the-art DSGE models:

Not rich enoughNot identified

Parameter and model uncertainty should be much more taken into account

Bayesian model averagingCommittee approach: there’s wisdom in crowds

To SummarizeNorges Bank’s approach is laudable:

Take recent developments in macro very seriously; can’t be all bad

Provides employment for PhD economists