2009 ASSA Metting: NABE Sessions on Business Cycles and Fed Policy
In the current financial and economic environment, business cycles and Fed actions are two subjects on the minds of business economists. Thus, it was both prescience and serendipity that Kevin Kliesen, St. Louis Fed economist and NABE board member (2002-2005), organized (eleven months ago) two NABE sessions on those topics that were presented at the ASSA meeting in San Francisco on January 2, 2009.
At “Dating U.S. Business Cycles and Troughs,” Robert Hall, chairman of the NBER Business Cycle Dating Committee, addressed the question, If the current recession began in December 2007, why didn’t the NBER recognize the downturn earlier than December 1, 2008? The major issue was the ambiguity in reported data. For example, payroll employment clearly peaked in December 2007, but quarterly real GDP exhibited multiple peaks and thus did “not speak clearly about the date of a peak in activity.” Hall also noted that the income-side equivalent of real GDP (real gross domestic income) displayed a pattern consistent with the Dating Committee’s decision. For a complete statement from the Committee, see the NBER website. Hall’s presentation is here.
James Hamilton, University of California-San Diego, used his well-known regime- switching model applied to real GDP to argue that a purely statistical algorithm not only accurately chooses the NBER dates, but tends to do so in a timelier manner. Hamilton noted that this recession is an exception, as his model would not have called the recession before the NBER did. Hamilton also offered a version using real time real GDP data. Hamilton’s presentation is here.
Edward Leamer, University of California-Los Angeles, agreed that an algorithm is needed because a “committee is a dangerous way to do science.” He argued that an appropriate model would be one that picks up the nonlinearities in the data—that is, the sudden changes in the pace of economic activity that occur around business cycle peaks and troughs. To that end, Leamer developed a model that looked at log changes over six-month periods (what he called “second derivatives”) of payroll employment, industrial production, and unemployment. Leamer’s presentation is here.
Hall responded by noting that the market was open for calling recessions and that the technology such as Hamilton and Leamer are using will help develop new ways to find turning points. In the meantime, the NBER has the franchise on calling business cycles.
James Bullard, president of the FRB of St. Louis, argued that the Federal Reserve was confronting a “two-headed dragon” as it attempted to formulate monetary policy” during “Long-run Economic Challenges—A Federal Reserve Perspective,” NABE’s second session. The risk of a deflation trap is one dragon, and the Fed has adopted policies to reduce this risk through quantative measures (i.e., using the Fed’s balance sheet), as opposed to targeting a nominal interest rate, at the December 2008 FOMC meeting. The risk of much higher future inflation—arising from failure to control the monetary base—is the second dragon. To reduce this risk, Bullard suggests a policy of inflation targeting. He noted that whatever the Fed does, its actions are likely to have long-term effects, as did the actions taken in 1979-82 under the Volcker Fed.
Charles Evans, president of the FRB of Chicago, touched on several points from his prepared remarks. He said that he supported a fiscal stimulus plan but worried about the stress it will impose on the government balance sheet and the burden it will impose on the taxpayer. He noted, “longer term challenges include restructuring the system of financial regulation and re-examining the role of market discipline.” For example, he argued that central clearinghouses were needed for derivative contracts, or financial institutions are likely to face increased regulation. He noted that recently, financial market discipline was missing, as evidenced by risk not priced correctly in the markets.
John Taylor, Stanford University and NABE Adam Smith Awardee, responded with a “Need to Return to a Monetary Framework.” He argued that the Fed had deviated from monetary policy rules that have worked in the past and helped to create and extend the Great Moderation. He detailed the growth of the Fed’s balance sheet in the fourth quarter 2008, and suggested that the growth was not motivated by monetary policy but by other reasons, such as industrialized policy, which should require Congressional oversight. Taylor raised the issues of whether the liquidity programs undertaken by the Fed were temporary and reversible, and whether the independence of the Fed was at risk due to its recent relationship with the Treasury Department. His slide presentation is here.
