1. Lecture 7. MONETARY POLICY
Economics 1490
THE WORLD ECONOMY:
GROWTH OR STAGNATION?
with
Professor Dale W. Jorgenson
Lecture 7. MONETARY POLICY
September 21, 2017
Harvard University Department of Economics
Fall 2017

2. THE WORLD ECONOMY:
GROWTH OR STAGNATION?
A. Comparing Economies
B. U.S. Crisis and Recovery
C. European Slowdown
D. Asian Economic Miracles
E. Sustainability of Economic Growth
F. World Economic Outlook

3. B. U.S. CRISIS AND RECOVERY
6. U.S. Financial Crisis
7. Monetary Policy 
8. Financial Regulation
9. Fiscal Policy 
10. Secular Stagnation

4. SUPPLEMENTARY READING
John B. Taylor (1993), “Discretion Versus Policy Rules in Practice,” Carnegie-Rochester Conference Series on Public Policy 39, pp
Lars Svensson (2010), “Inflation Targeting,” Ch. 22 in Benjamin M. Friedman and Michael J. Woodford, eds., Handbook of Monetary Economics, Amsterdam, Elsevier, pp
Ben S. Bernanke (2015), “The Taylor Rule: A Benchmark for Monetary Policy,” Washington, DC, The Brookings Institution, April 28.

5. BEN S. BERNANKE

6. THE COURAGE TO ACT

7. BEN S. BERNANKE BIOGRAPHY
14th Chairman of the Federal Reserve, Sworn In February 1, 2006.
Born Augusta, Georgia, December 13, 1953; Raised in Dillon, South Carolina.
Harvard College, B.A. in Economics, summa cum laude, in Resided in Winthrop House.
MIT Ph.D. in Economics in 1979.
Taught at Stanford Business School and Princeton University.
Member of the Federal Reserve Board of Governors, Chairman of the President’s Council of Economic Advisers under George W. Bush, 2005 until appointment as Chairman of the Fed.

8. THE FEDERAL RESERVE AND THE CRISIS
BEN S. BERNANKE:
THE FEDERAL RESERVE AND THE CRISIS
The Global Financial Crisis and the Great Recession
Triggers and Vulnerabilities
Analogy with the Dot-Com Bubble
Initially Moderate Losses to Subprime Mortgage Holders Cascaded Throughout the System.

9. PRIVATE SECTOR VULNERABILITIES
High Levels of Leverage
Excessive Dependence on Unstable Short-Term Funding
Deficiencies in Risk Management
Use of Exotic Financial Instruments

10. PUBLIC SECTOR VULNERABILITIES
BEN S. BERNANKE:
PUBLIC SECTOR VULNERABILITIES
Gaps in the Regulatory Structure
Failure of Supervisors/Regulators
Insufficient Attention to Threats to the Stability of the Financial System as a Whole

11. THE FEDERAL RESERVE’S REACTION
BEN S. BERNANKE:
THE FEDERAL RESERVE’S REACTION
The Fed Provided Liquidity to Commercial Banks and Other Financial Institutions, Such as Investment Banks and Money Market Funds.
The Fed Also Provided Liquidity to Borrowers and Investors in Key Asset Markets.
The Fed Approved Currency Swap Agreements with 14 Central Banks.
The Fed Conducted Stress Tests of the Largest Banks.

12. BEN S. BERNANKE: REGULATORY REFORM
Bank Capital Regulation under Basel III
Comprehensive Capital Analysis and Review (CCAR)
Financial Stability Oversight Council
Office of Financial Stability and Research

13. BEN S. BERNANKE: MONETARY POLICY
Federal Funds Rate Has Been at Its Effective Lower Bound since the End of 2008
Enhanced Forward Guidance
Large Scale Purchases of Longer-Term Securities (Quantitative Easing)
Bank of Japan, Bank of England, European Central Bank Policies

14. BEN S. BERNANKE: UNCONVENTIONAL MONETARY POLICY AND RETURN TO NORMAL
The Combination of Forward Guidance and Quantitative Easing Has Helped Promote the Recovery
Tools to Normalize Monetary Policy: Interest Rates on Deposits with the Fed, Drain Bank Reserves and Tighten Control over Money Market Rates
FOMC Will Return to Conducting Monetary Policy by Adjustments in the Short-Term Policy Rate
Operating Framework May Change in Light of Experience with Unconventional Monetary Policy

15. JOHN B. TAYLOR

16. JOHN B. TAYLOR BIOGRAPHY
Mary and Robert Raymond Professor of Economics, Stanford University.
Born in Yonkers, New York, December 8, 1946.
Princeton University, B.A. in Economics, summa cum laude, in 1968.
Stanford University, Ph.D. in Economics, in 1973.
Taught at Columbia, Princeton, and Stanford.
Member of the President’s Council of Economic Advisers under George H.W. Bush, Undersecretary for International Affairs,

17. TAYLOR’S VIEW OF THE FINANCIAL CRISIS
The Panic of 2008
The Fed Held Interests Rates Too Low, Beginning Around 2003
Affordable Housing Policy Promoted an Expansion of Mortgage Lending
The Fed Pursued an Ad Hoc Bailout Policy
The Fed Adopted Unconventional Monetary Policy

18. THE PANIC OF 2008

19. TAYLOR’S RULE FOR MONETARY POLICY
If the Federal Reserve’s Inflation Target is Two Percent:
FFR = π GAP (π – 2) + 2
Where:
FFR – federal funds rate
π – inflation rate
GAP – ln GDP(actual) – ln GDP(potential)

20. NUMERICAL EXAMPLE OF TAYLOR’S RULE
Taylor’s Rule Reduces to:
FFR = 1.5 π GAP + 1
Example: In 1989 at the beginning of the Great Moderation:
The FFR was 10%.
1.5 times the inflation rate (π) of 5%
+ 0.5 times the gap of 3% (actual GDP was greater than potential) + 1%
7.5% + 1.5% + 1% = 10%

21. INFLATION TARGETING
Inflation Targeting is a Monetary Policy with a Fixed Inflation Target.
Flexible Inflation Targeting: The Taylor Rule with a Lag or Lead
Before the Crisis Twenty-Five Banks Used Inflation Targeting
This Included the Bank of Canada and the Bank of England, but Not the Federal Reserve

22. CHANGES IN MONETARY POLICY LEADING UP TO CRISIS

23. CENTRAL BANK PREFERENCES

24. TAYLOR FRONTIER
Source: Figures 4 and 5 and Mervyn King’s Stamp Memorial Lecture, Oct. 9, 2012.

25. SHIFTING FROM LIQUIDITY OPERATIONS

26. TAYLOR RULES

27. THE FEDERAL RESERVE’S AD HOC BAILOUT POLICY
Bailout of Bear Stearns
The Lehman Bankruptcy
The Troubled Asset Relief Program (TARP)
Modification of TARP on September 19, 2008

28. STOCK MARKETS BEFORE AND AFTER

29. THE SLOW RECOVERY Taylor: Policy is the Problem
Reinhart-Rogoff: The Financial Crisis
Summers: Secular Stagnation

30. ECONOMIC GROWTH FOLLOWING RECOVERIES

31. THE BERNANKE-TAYLOR DEBATE:
SUMMARY
Bernanke and Taylor Agree on the NICE Period
Taylor Argues That the Fed Ended the NICE Period
Bernanke and Taylor Disagree on the Zero Interest Rate Bound
They Also Disagree on Unconventional Monetary Policy