SENIOR VICE PRESIDENT AND
DIRECTOR OF RESEARCH
ROBERT A. EISENBEIS
THOMAS J. CUNNINGHAM
Vice President and
Associate Director of Research
GERALD P. DWYER JR.
Vice President, Financial
JOHN C. ROBERTSON
Assistant Vice President, Regional
ELLIS W. TALLMAN
Assistant Vice President, Macropolicy
BOBBIE H. MCCRACKIN
LYNN H. FOLEY
CAROLE L. STARKEY,
PETER HAMILTON, AND JILL DIBLE
Marketing and Circulation
The Economic Review of the Federal Reserve Bank of Atlanta, published quarterly, presents analysis of economic and financial topics relevant to Federal Reserve policy. In a format accessible to the nonspecialist, the publication reflects the work of the Research Department. It is edited, designed, produced, and distributed through the Public Affairs Department.
Views expressed in the Economic Review are not necessarily those of this Bank or of the Federal Reserve System.
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|On Business Cycles and Countercyclical Policies
|Marco A. Espinosa-Vega and Jang-Ting Guo
Since the third quarter of 2000, the U.S. economy began to experience a slowdown in its rate of growth. This slowdown serves as a reminder that the business cycle is still alive and raises the following questions: What do we know about the driving forces behind the business cycle? What should policymakers do in the face of economic fluctuations?
The authors examine two explanations for business cycles that are well-known in academic circles: the animal spirits theory and the real business cycle theory. The former is closely connected with the Keynesian economic tradition and identifies market participants’ mood swings as the key source of economic fluctuations. The second explanation is rooted in the classical economic tradition and views productivity shocks as the driving force behind economic fluctuations. The article then looks at what these theories suggest about countercyclical policies, which try to eliminate business cycle fluctuations or insulate market participants from their effects. The authors conclude that neither theory makes an unambiguous case supporting countercyclical policies.
This conclusion may come as a surprise to government and business economists who have an ingrained belief in the benefits of such policies. It is important to remember, however, that attempts to understand business cycles and the effects and desirability of policies that may (or may not) moderate them are still at a very early stage.
What Remains of Monetarism?
In October 1979 the Federal Reserve, in an attempt to curb double-digit inflation, announced that it would place more weight on monetary aggregates in policy deliberations. This policy shift helped reduce inflation but sent the economy into a recession. Three years later the Fed abandoned monetary targets and returned to targeting the federal funds rate.
Monetary growth targets currently play no official role in the setting of U.S. monetary policy. Is such disregard justified by the data any more today than it was twenty years ago? This article provides a historical perspective on the development and apparent failure of monetarism as a policy guide.
The author also explores whether the basic monetarist propositions still hold true for a sample of fifteen countries. The analysis suggests that it is premature to dismiss monetary aggregates as uninformative. The data from the economies studied indicate that, in general, nominal income growth and inflation are positively related to money growth. While these results do not support short-term manipulation of the monetary aggregates to deliver precise control over movements in income and prices, they also do not reject the notion that changes in money growth have important long-term effects on the economy. What the results suggest, therefore, is that failure to acknowledge this empirical fact could lead to undesirable policy consequences.
|Assessing Simple Policy Rules: A View from a Complete Macroeconomic Model
|Eric M. Leeper and Tao Zha
Monetary policy analysts looking for a model on which to base decisions may consider two popular approaches—the New Keynesian (NK) and the identified vector autoregression (VAR) approaches. Choosing between the two can be difficult: NK models are stylized and have simple rules while structural VAR models have complex dynamics and loose behavioral interpretations.
The simpler NK models often produce stark conclusions. For example, NK analyses consistently find that the Federal Reserve’s monetary policy has improved markedly in the past two decades compared with the 1960s and 1970s. In contrast, VARs find little instability in the policy parameters or in the dynamic impacts of exogenous shifts in policy.
Taking the view that NK models are simply restricted VARs, the authors estimate systems of structural equations implied by NK models. They find that these estimated equations vary considerably over different periods. The authors also investigate the role of money by incorporating money (M2) into the NK model; they find that including money substantially alters the model’s conclusions about monetary policy. This result conflicts with the NK theoretical assumption that money is irrelevant.
Both NK models and VARs have their place in policy advising, the authors believe. But they caution that it is treacherous to draw inferences about policy effects solely from policy rules estimated in isolation from a complete macro model.