did the fed act gradually? estimating changes in inflation pressure in real time pierre l. siklos,...
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Did the Fed Act Gradually? Estimating Changes in
Inflation Pressure in Real Time
Pierre L. Siklos, WLUDiana N. Weymark, Vanderbilt
Motivation
Focus
Vintages Examined so far
August 1998 May 2002 November 2002 May 2004
Full sample: 1970-end of vintage Sub-sample: 1980- end of vintage
What is Inflation Pressure? I
What is Inflation Pressure? II
The Ups and Downs of the fed funds rate
The 2004-2005 period is especially interesting because of the ‘conundrum’ (rotating yield curve; Backus and Wright 2007) Inflation was also generally held in check
Other episodes? Jan 2001- June 2003 easing: 70% of reductions were
5obp at a time. June 1989 – Sept 1992: 25bp cuts 90% of the time 1994-95, 1999-2000, 2004-06 tightening usually
involved 25bp rises, with 50bp increases infrequent
Target Fed funds rate I
0
2
4
6
8
10
121/1
/1983
1/1
/1984
1/1
/1985
1/1
/1986
1/1
/1987
1/1
/1988
1/1
/1989
1/1
/1990
1/1
/1991
1/1
/1992
1/1
/1993
1/1
/1994
1/1
/1995
1/1
/1996
1/1
/1997
1/1
/1998
1/1
/1999
1/1
/2000
1/1
/2001
1/1
/2002
1/1
/2003
1/1
/2004
1/1
/2005
1/1
/2006
1/1
/2007
Per
cent
Target Fed funds rate: II
0
1
2
3
4
5
6
7
Per
cent
Measuring the Impact of Monetary Policy
Measuring the Impact of Monetary Policy
Introducing Measures of Inflation Pressure
BUT….
Counterfactual Experiments are Needed
Methodology: Outline
The Model for the US Economy
1 1 2 1[ ]t t t t t t ty i E E y u
tttttt ey~E 31211
0 1 (1 )[ ]
, 0
t t t t m y t t n ti i E E y
m n
Solving the Model
Conjecture a solution & solve using TR
1 2 3 1t t t ty u e i
1321 tttt ieu
Solving the Model: I
Solving the Model: II
Solving the Model: III
Solving the Model: EAIP
Ex Post IP (EPIP): I
EPIP: II
Indicators of Monetary Policy: I PIIPt
=0 No change in IP =1 Inflation held
constant <0 MP underreacts
to IP (actually raises it) > 1 MP ‘overshoots’*
*opposite sign 0<PIIP<1 MP
reduces some IP
0
1ti
t t tt
t t
PIIPEAIP EAIP
Indicators of Monetary Policy: II MPEt
=1 MP completely effective
=0 MP ineffective or ‘neutral’
<0 MP unsuccessful IP maginfied
> 1 MP ‘overshoots’* *opposite sign
0<MPE<1 MP partially effective
1 tt
t
EPIPMPE
EAIP
Measuring IP with Quarterly Data There is a ‘control’ lag between the interest
rate and inflation Therefore IP is the inflation observed at time
t if the interest rate at time t-1 (or t, t-2, depending on the lag structure) had been held constant at its t-2 level
Interest rates in other periods generated by the policy maker’s TR
IP captures the impact on inflation of a one-period deviation from the TR
US Real Time Data
Federal Reserve Bank of Philadelphia Real-Time Data Set
Interest rates and consumer prices are from the Federal Reserve Bank of St. Louis’ FRED II
The real interest rate: Greenbook, SPF, UMich survey, Economist, Consensus
Output Gap: H-P filter & CBO estimates
Inflation Rates
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
CPI Pers Cons Exp Implicit Price deflator
Per
cent
Real Interest Rates
-4
0
4
8
12
16
1970 1975 1980 1985 1990 1995 2000 2005
Greenbook University of MichiganSPF ConsensusAverage one year ahead inflation
Per
cent
Output gap: final revised
-.10
-.08
-.06
-.04
-.02
.00
.02
.04
1970 1975 1980 1985 1990 1995 2000
H-P filter CBO estimates
Illustration of Model Estimates
Ex Ante IP: I
0
4
8
12
16
20
24
1970 1975 1980 1985 1990 1995 2000 2005
1998 08 1998 08 2004 052002 11 2002 05
Ex
ante
Lev
el o
f In
flat
ion
Ex Ante IP: II
0
4
8
12
16
20
24
1980 1985 1990 1995
Ex ante inflation Pressure: full sampleActual inflationEx ante inflation Pressure: sub sample
Per
cent
PIIP: Post 1980 Sample
-.05
.00
.05
.10
.15
.20
.25
.30
.35
80 82 84 86 88 90 92 94 96 98
May 2002 May 2004August 1998 November 2002
Pol
icy In
duce
d In
flat
ion Pre
ssur
e
MPE: Post 1980 sample
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1970 1975 1980 1985 1990 1995 2000 2005
08 1998 11 2002 08 199805 2004 05 2002
Mon
etar
y Pol
icy Effec
tive
ness
Ind
icat
or
Conclusions The Fed may have acted gradually simply because it was largely
successful in influencing expectations of future inflation The Fed was not always conducting a successful monetary policy
November 2002: MP was clearly unsuccessful since inflationary pressure ex post was higher than ex ante
Nevertheless, a sharp turnaround took place by the time of the May 2004 vintage
The biggest impact on monetary policy performance occurs not because the Fed changes its policy rate but via the changes in inflationary expectations these changes promote
Our results not only reinforce the dramatic revisions in our assessment of the conduct of monetary policy based on real time data
Models that evaluate policies based on data that stretch back before 1980 must allow for the fact that a notable structural shift
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