The economy behaved just a ‘prescribed’ by monetary policy

Econbrowser links to a study by Blinder and Zandi, who develop the counterfactual::

Or, one can appeal to extant estimates of multipliers to estimate how the economy would have performed in the absence of fiscal and monetary stimulus and financial system rescuses. That is exactly what is done in a Blinder-Zandi CBPP study, with the results shown in Figure 1.


My take is simpler. There was an initial massive monetary failure, which allowed nominal aggregate spending (NGDP) to crumble. A belated and timid monetary policy reaction, starting with QE1 breathed a little air into the tire, enough for it to “slowly” roll up the hillside.


I agree that the rescue operation for banks and others, in addition to the timid monetary policy reaction, “saved” the economy from the financial propagation mechanism that continued to punish the economy in 1931/32.

In their exercise, B-Z write:

To quantify the economic impacts of the aforementioned panoply of policies, we simulated the Moody’s Analytics model of the U.S. economy under different counterfactual scenarios. In all scenarios, the federal government’s automatic stabilizers—the countercyclical tax and spending policies that are implemented without explicit approval from Congress and the administration—are assumed to operate. So is the traditional monetary policy response via the Federal Reserve’s management of short-term interest rates, albeit constrained by the zero lower bound

To assess the full impact of the policy response, the “No Policy Response” scenario assumes that, apart from the above, policymakers simply sit on their hands in response to the crisis.

So I wonder what makes the economy turn around so briskly after 2011. The turnaround in March 1933 was the direct and immediate result of a monetary regime change.


Alan Blinder thinks the interest rate trajectory defines the stance of monetary policy

Michael Darda to Scott:

Alan Blinder in today’s WSJ, arguing, as some Fed officials have, that it’s not the start/timing of the initial rate hike/tightening that matters, it’s the trajectory. This is just incredibly wrongheaded in virtually every respect. If the Fed is overlooking a passive tightening in monetary/financial conditions and a concomitant drop in the eq. short rate and then compounds it by actively tightening instead of easing, the “trajectory of short rates” will be very shallow indeed. The “path” of short rates was “only” 25 bps in Japan in 2000, “only” 50 bps in Japan in 2006/7 and “only” 50 bps in the EZ in 2011. And the outcomes were all consistent with monetary policy failure.

Memo to Blinder: Never reason from an interest rate path.

Scott comments:

This is a very important point. In the three episodes mentioned by Darda, the trajectory of interest rates was extremely flat, after the initial increase. And yet in all three cases monetary policy was far too contractionary, and in all three cases the country (or region) again fell back to the zero rate boundary. The Fed may avoid that mistake, but it won’t be because a flat interest rate trajectory means easy money. I’d guess that about 90% of interest rate movements reflect the condition of the economy, and 10% reflect Fed policy.

Blinder’s right that the future path of policy is very important, but wrong in assuming that the future path of interest rates tells us anything useful about the future path of policy.

Which reminded me of 1993-95, At that time, the Fed chose a “steep” path for the FF target rate. Was policy “tight”?

The nominal side:


Where it is hard to assign a “policy role” to the FF rate. After all, inflation fell while the FF rate was “dead” and stopped falling when the FF rate increased rapidly!

Now look at what went on with NGDP. It is clearly much more relevant to what happened to inflation.

The real side:


RGDP growth and the fall in unemployment pick up when NGDP growth rises (despite the rise in the FFT) . What the Fed successfully did was to put the nominal economy back on track after the 1990/91 recession and importantly, with a permanently lower rate of inflation. The real economy says “thanks”!

Note: Apparently, the Fed was also successful in “tracking” the equilibrium interest rate!

Much later, the “Great Inflation” was pinned on poor monetary policy. How long will it take to blame monetary policy for the “repressed economy” since 2008?

The conflicting conclusions from these “old” arguments are still present today!

Alan Blinder (2009)

From the end of 2002 to the middle of 2008, the US economy was in the throes of a significant oil price shock. The dollar price of oil rose fivefold, with spot prices briefly hitting $145/barrel. Even adjusting for inflation, the rise in oil prices was stunning. At their peak, real oil prices stood about 50% above their previous record high – reached following the second OPEC oil shock of 1979-80. (After hitting its 2008 peak, the price of oil fell rapidly, tumbling over the past six months into the $30-$50/barrel range.)

Although the recent run-up in oil prices is comparable in magnitude to the first two OPEC shocks, its effects on the economy seem to have been very different. Textbook accounts of the 1970s and early 1980s blame “supply shocks” (which included sharp rises in the price of food as well as oil) for the prolonged periods of both high unemployment and high inflation, or “stagflation,” that followed.

By contrast, the most recent increase in oil prices appeared to have very little effect on the expansion that followed the 2001 recession. (While the US economy did enter a recession at the end of 2007, this was widely attributed to the collapse in consumer and business confidence that attended the subprime crisis and subsequent financial panic.) Similarly, core consumer price inflation – inflation excluding food and energy prices – was relatively stable over this period, which again contrasts sharply with the earlier episodes.

One interpretation of the experience of the past several years is that it vindicates “revisionist” views of the role played by oil shocks (and other supply shocks) in precipitating the stagflation of the 1970s. According to this view – variants of which have been propounded by DeLong (1997), Barsky and Kilian (2002), and Cecchetti et al. (2007) – the root cause of the abysmal macroeconomic performance from 1973 to 1983 was poor monetary policy, not the oil shocks.

Jim Hamilton (2009)

The implication that almost all of the downturn of 2008 could be attributed to the oil shock is a stronger conclusion than emerged from any of the other models surveyed in my Brookings paper, and is a conclusion that I don’t fully believe myself. Unquestionably, there were other very important shocks hitting the economy in 2007-08, first among which would be the problems in the housing sector. But housing had already been subtracting 0.94% from the average annual GDP growth rate over 2006:Q4-2007:Q3, when the economy did not appear to be in a recession. And housing subtracted only 0.89% over 2007:Q4-2008:Q3, when we now say that the economy was in recession. Something in addition to housing began to drag the economy down over the later period, and all the calculations in the paper support the conclusion that oil prices were an important factor in turning that slowdown into a recession.

Let´s consider Jim´s arguments first: There´s no doubt, just imagining a dynamic AS-AD model that a price shock increases inflation and reduces real output, so Jim´s conclusion is not special. But the strength of the oil price effect on real output is predicated on how the Fed reacts to the shock.

If the Fed reacts to the rise in inflation by contracting nominal spending (NGDP), real output is going to decrease more than if the Fed kept nominal spending “constant”. This is clearly seen in the following graph, representing a dynamic AS-AD model, where point 1 is the initial state and points 2 and 3 represent, respectively, the states following the oil price shock and the oil shock cum contraction in AD:

When will MP take blame_1

There´s an interesting experiment to be made. In 2003-2006 the economy was buffeted by an oil price shock that was even stronger (higher percent price increase) than the one that occurred in 2007-08. This is shown in the charts below.

When will MP take blame_2

As the next charts indicate, in the 2003-06 period NGDP growth was kept stable, so that RGDP growth was only little reduced. This was not the case in 2007-08. In the later period, the Fed remained so worried about inflation that it kept contracting NGDP and that´s the reason a “run of the mill recession” became “Great”!

When will MP take blame_3

Going back to Blinder, he´s very off hand about the “Great Recession”. Unlike the 1970s, he thinks it had nothing to do with monetary policy. Maybe that reflects his concentration on the inflation side of the ledger!

I wonder if it will take another 25 or thirty years for someone to say “the root cause of the abysmal macroeconomic performance from 2008 onwards was extremely poor monetary policy, (not the oil shocks, subprime crisis and ensuing financial panic)