1. Policy Rule Legislation in Practice
Alex Nikolsko-Rzhevskyy
Lehigh University
David Papell and Ruxandra Prodan
University of Houston

2. Federal Reserve Accountability and Transparency Act
Negative Reaction
Janet Yellen – A “grave mistake” which would “essentially undermine central bank independence.”
Alan Blinder – In a town like Washington, the message to the Fed would be clear. Depart from the original Taylor rule at your peril.”
Janet Yellen – “I’m not a proponent of chaining the Federal Open Market Committee in its decision making to any rule whatsoever.”
Positive Reaction
Allan Meltzer – “So you need a rule which says, look, you said you were going to do this, and you have not done it. That requires an answer, and that I think is one of the most important reasons why we need some kind of a rule.”

3. Objective of the Paper
Suppose that Policy Rule Legislation Enacted for Past 60 Years
When Would the Fed Have Been in Compliance?
When Would Deviations Have “Required an Answer”? (Meltzer)
We Consider Several Rules Over Different Periods
Original Taylor Rule
Modified Taylor Rule with Higher Output Gap Coefficient
What Does it Mean to be Out of Compliance?
The Fed Chooses and Can Change the Rule
Trivial Compliance by Frequent Changes in the Rule
Focus on Compliance Over Extended Periods

4. Policy Rules Legislation
Federal Reserve Accountability and Transparency Act of 2014
House of Representatives Bill
Directive Policy Rule Chosen by the Fed
Describes How Policy Instrument Would Respond to a Change in the Intermediate Policy Inputs
Deviations from the Rule
Fed Chair Required to Testify Before Appropriate Congressional Committees
Statement Whether Directive Policy Rule Substantially Conforms to the Reference Policy Rule
Original Taylor Rule

5. Policy Rules Legislation
Financial Regulatory Improvement Act of 2015
Draft Senate Bill
Policy Rule Similar to Directive Policy Rule Chosen by the Fed
No Equivalent to Reference Policy Rule
Replace Semi-Annual Monetary Policy Report to Congress by the Federal Reserve Board with Quarterly Report by the FOMC
Continues Semi-Annual Testimony by Fed Chair

6. Policy Rules Legislation
Neither Bill Defines a Deviation
What Does “Out of Compliance” mean?
Nikolsko-Rzhevskyy, Papell, and Prodan (2014)
Paper Presented at Hoover Conference Last May
Statistical Methods to Determine Rules-Based and Discretionary Eras
Deviations from Original Taylor Rule Less Than/Greater Than 2 Percent
Correlation of 0.8 with Rules-Based/Discretionary Eras
We Define Deviations as Greater than Two Percent from Prescribed Rule

7. Policy Rules Original Taylor (1993) Rule
FFR = Inflation Output Gap
Time-Varying Equilibrium Real Interest Rate
FFR = Inflation Output Gap + TVERIR
Modified Taylor Rule – Yellen (2012) Balanced Approach Rule
FFR = Inflation Output Gap

8. Policy Rules From 1954 to 2015
Federal Funds Rate Data from 1954:Q3 – 2015:Q1
Zero Lower Bound
Use Shadow FFR from Wu and Xia (2014). Negative Starting in 2009:Q1
Real-Time Data That Was Publicly Available
GDP and GDP Deflator from Philadelphia Fed
Construct Output Gaps with Linear Detrending Until 1973 and Quadratic Detrending Thereafter
Congruence with Real-Time Okun’s Law Gaps
We Don’t Use Greenbook Output Gap or Inflation Forecast Data
Moral Hazard Problem (Perceived or Actual)
Original and Modified Taylor Rules

9. Original Taylor Rule: 1954-2015

10. Modified Taylor Rule: 1954-2015

11. Policy Rules From 1954 to 2015 Taylor (1999)
“too high in the early 1960s, too low in the late 1960s, to low in the 1970s, on track in , too high in , and on track in the late 1980s and 1990s.”
No Need to Modify Quote for Real-Time Data
Justification for Deviations
Inflation Forecasts Don’t Work for the 1970s
Deviations Starting in 1976:Q1 with Original Taylor Rule
Credibility in the Early 1980s
Virtually No Deviations in the Great Moderation
Mixed Results in the 2000s

12. Policy Rules From 1991 to 2015
Congressional Budget Office Real-Time Output Gaps
CBO Real-Time Potential GDP and Philadelphia Fed Real-Time GDP
Poole (2007) and Taylor (2007)
CPI Inflation
Kohn (2007)
Core CPI Inflation
Bernanke (2010)
Core PCE Inflation (Proxy for Inflation Forecasts)
Yellen (2012)
Modified Taylor Rule with PCE Inflation
Yellen (2015)
Original Taylor Rule with TVERIR (Revised and Real-Time)

13. Original Taylor Rule with Real-Time CBO Output Gaps and CPI Inflation: 1994-2015

14. Original Taylor Rule with Real-Time CBO Output Gaps and PCE Inflation: 1991-2015

15. Original Taylor Rule with Real-Time CBO Output Gaps and Core CPI Inflation: 1999-2015

16. Original Taylor Rule with Real-Time CBO Output Gaps and Core PCE Inflation: 1996-2015

17. Modified Taylor Rule with Real-Time CBO Output Gaps and PCE Inflation: 1991-2015

18. Original Taylor Rule with Real-Time CBO Output Gaps, PCE Inflation and Time-Varying Equilibrium Real Interest Rates:

19. Policy Rules From 1991 to 2015 Poole (2007) and Taylor (2007)
Deviations in
Deviations in 2011 to 2015
Alternative Policy Rules and Inflation Measures
Eliminate Deviations for Targeted Period
Creates Deviations for Previous and Subsequent Periods

20. Conclusions Policy Rule Legislation from 1954 to 2015
Policy Generally in Compliance from 1954 to 1975
Exception for Late 1960s
Policy Generally Not in Compliance from 1975 to 1985
Great Inflation and Volcker Disinflation
Policy in Compliance During Great Moderation
Mixed Results for the 2000s and 2010s
Rules that Produce Compliance for One Period Cause Violations of Compliance in Other Periods
Pessimistic that Rules for which the Fed is in Compliance Today Will Provide Compliance Going Forward