Richard Fisher and the Output Gap
I've been posting about this topic from time to time on Bonobo Land ), and about how our idea of a national output gap may be somewhat quaint and outdated in a globalised world. "The global output gap" idea of Borrio and Filardo is an interesting one. To a great extent I go along with Dallas Fed President Richard Fisher's argument that in a globalised world the idea of a national output gap is less and less relevant, but globally the idea makes much more sense. This also fits in with Andy Xie's methodological proposal that in macro terms we stop thinking about the global economy as an agglomeration of individual partially-open economies, and instead consider it one single 'developing economy' with a lot of regional market imperfections (home bias etc). Personally I find this idea makes a lot more sense.
You can find a good example of Fisher's speeches here:
The literature on globalization is large. The literature on monetary policy is vast. But literature examining the combination of the two is surprisingly small.
I believe globalization and monetary policy are intertwined in a complex narrative that is only beginning to unfold.
There are many convoluted definitions of globalization. Mine is simple: Globalization means economic potential is no longer constrained by political and geographic boundaries. A globalized world is one where goods, services, capital, money, workers and ideas migrate to wherever they are most valued and can work together most efficiently, flexibly and securely.
Where does monetary policy come into play in this world? Well, consider the task of the central banker, seeking to conduct monetary policy to achieve maximum sustainable non-inflationary growth.
Former Federal Reserve Governor Larry Meyer gave an insider’s view of the process in his excellent little book A Term at the Fed. It was one of the first things I read as I prepared for my new job. In it, you get a good sense of the lexicon of monetary policy deliberations. The language of Fedspeak is full of sacrosanct terms, such as “output gap” and “capacity constraints.” There is the “natural rate of unemployment,” which morphed into “the non-accelerating inflation rate of unemployment,” or “NAIRU.” Central bankers want GDP to run at no more than its theoretical limit, for growing too fast for too long might stoke the fires of inflation. They do not wish to strain the economy’s capacity to produce.
One key capacity factor is the labor pool. A shibboleth known as the Phillips curve posits that unemployment falling beneath a certain level ignites demand for greater pay, with inflationary consequences for the entire economy.
Until recently, the econometric calculations of the various capacity constraints and gaps of the U.S. economy were based on assumptions of a world that exists no more. Meyer’s book is a real eye-opener because it describes in great detail the learning process of the FOMC members as the U.S. economy entered a new economic environment in the second half of the 1990s. At the time, economic growth was strong and accelerating. The unemployment rate was low, approaching levels unseen since the 1960s. In these circumstances, inflation was supposed to rise—if you believed in the Phillips curve and the prevailing views of potential output growth, capacity constraints and the NAIRU. That is what the models used by the Federal Reserve staff were saying, as was Meyer himself, joined by nearly all the other Fed governors and presidents gathered around the FOMC table. Under the circumstances, they concluded that monetary policy needed to be tightened to head off the inevitable. They were frustrated by Chairman Greenspan’s insistence they postpone the rate hikes.
We now recognize with 20/20 hindsight that Greenspan was the first to grasp changes in the traditional relationships among economic variables. The former chairman understood the data and the Fed staff’s modeling techniques, but he was also constantly talking—and listening—to business leaders. And they were telling him they were simply doing their job of seeking any and all means of earning a return for shareholders. At the time, they were being enabled by new technologies that enhanced productivity. The Information Age had begun rewriting their operations manuals. Earnings were being leveraged by technological advances. Productivity was surging. Inflation wasn’t rising. Indeed, it just kept on falling.
You can find a good example of Fisher's speeches here:
The literature on globalization is large. The literature on monetary policy is vast. But literature examining the combination of the two is surprisingly small.
I believe globalization and monetary policy are intertwined in a complex narrative that is only beginning to unfold.
There are many convoluted definitions of globalization. Mine is simple: Globalization means economic potential is no longer constrained by political and geographic boundaries. A globalized world is one where goods, services, capital, money, workers and ideas migrate to wherever they are most valued and can work together most efficiently, flexibly and securely.
Where does monetary policy come into play in this world? Well, consider the task of the central banker, seeking to conduct monetary policy to achieve maximum sustainable non-inflationary growth.
Former Federal Reserve Governor Larry Meyer gave an insider’s view of the process in his excellent little book A Term at the Fed. It was one of the first things I read as I prepared for my new job. In it, you get a good sense of the lexicon of monetary policy deliberations. The language of Fedspeak is full of sacrosanct terms, such as “output gap” and “capacity constraints.” There is the “natural rate of unemployment,” which morphed into “the non-accelerating inflation rate of unemployment,” or “NAIRU.” Central bankers want GDP to run at no more than its theoretical limit, for growing too fast for too long might stoke the fires of inflation. They do not wish to strain the economy’s capacity to produce.
One key capacity factor is the labor pool. A shibboleth known as the Phillips curve posits that unemployment falling beneath a certain level ignites demand for greater pay, with inflationary consequences for the entire economy.
Until recently, the econometric calculations of the various capacity constraints and gaps of the U.S. economy were based on assumptions of a world that exists no more. Meyer’s book is a real eye-opener because it describes in great detail the learning process of the FOMC members as the U.S. economy entered a new economic environment in the second half of the 1990s. At the time, economic growth was strong and accelerating. The unemployment rate was low, approaching levels unseen since the 1960s. In these circumstances, inflation was supposed to rise—if you believed in the Phillips curve and the prevailing views of potential output growth, capacity constraints and the NAIRU. That is what the models used by the Federal Reserve staff were saying, as was Meyer himself, joined by nearly all the other Fed governors and presidents gathered around the FOMC table. Under the circumstances, they concluded that monetary policy needed to be tightened to head off the inevitable. They were frustrated by Chairman Greenspan’s insistence they postpone the rate hikes.
We now recognize with 20/20 hindsight that Greenspan was the first to grasp changes in the traditional relationships among economic variables. The former chairman understood the data and the Fed staff’s modeling techniques, but he was also constantly talking—and listening—to business leaders. And they were telling him they were simply doing their job of seeking any and all means of earning a return for shareholders. At the time, they were being enabled by new technologies that enhanced productivity. The Information Age had begun rewriting their operations manuals. Earnings were being leveraged by technological advances. Productivity was surging. Inflation wasn’t rising. Indeed, it just kept on falling.
