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FEDERAL RESERVE BANK OF SAN FRANCISCO
WORKING PAPER SERIES
Riders on the Storm
Òscar Jordà
Federal Reserve Bank of San Francisco
University of California, Davis
Alan M. Taylor
University of California, Davis
NBER, and CEPR
September 2019
Working Paper 2019-20
https://www.frbsf.org/economic-research/publications/working-papers/2019/20/
Suggested citation:
Jordà, Òscar, Alan M. Taylor. “Riders on the Storm,” Federal Reserve Bank of San
Francisco Working Paper 2019-20. https://doi.org/10.24148/wp2019-20
The views in this paper are solely the responsibility of the authors and should not be interpreted
as reflecting the views of the Federal Reserve Bank of San Francisco or the Board of Governors
of the Federal Reserve System.
RidersontheStorm
ÒscarJordà AlanM.Taylor
FederalReserveBankofSanFranciscoandUniversityofCalifornia,Davis
UniversityofCalifornia,Davis,NBER,andCEPR
[email protected]@ucdavis.edu
Abstract
Interestratesinmajoradvancedeconomieshavedrifteddownandingreaterunisonoverthepastfewdecades.Acountry’srateofinterestcanbethoughtofasreflectingmovementsintheglobalneutralrateofinterest,thedomesticneutralrate,andthestanceofmonetarypolicy.Onlythelatteriscontrolledbythecentralbank.EstimatesfromastatespaceNewKeynesianmodelshowthatcentralbankpolicyexplainslessthanhalfofthevariationininterestrates.Therestofthetime,thecentralbankiscatchinguptotrendsdictatedbyproductivitygrowth,demography,andotherfactorsoutsideofitscontrol.Keywords:neutralrateofinterest,monetarypolicystance,state-spacemodel,KalmanfilterJELcodes:E43,E44,E52,E58,F36,N10*PresentedattheFederalReserveBankofKansasCityEconomicPolicySymposium“ChallengesforMonetaryPolicy,”JacksonHole,Wyoming,August22–24,2019.FortheirmosthelpfulcommentswethankBenBernanke,OlivierBlanchard,Pierre-OlivierGourinchas,AndrewHaldane,MauriceObstfeld,ŁukaszRachel,MoritzSchularick,SanjaySingh,andLawrenceSummers.Allerrorsareourown.TheviewsexpressedhereinaresolelytheresponsibilityoftheauthorsandshouldnotbeinterpretedasreflectingtheviewsoftheFederalReserveBankofSanFranciscoortheBoardofGovernorsoftheFederalReserveSystem.
1
Hestoodinreverentialaweofhimself;hehadperformedamiraculousfeat.Theactoffindinghimselfonthefaceofthewatersbecamearite,andhefelthimselfasuperiorbeingtotherestofuswhoknewnotthisriteandweredependentonhimforbeingshepherdedacrosstheheavingandlimitlesswaste,thebrinyhighroadthatconnectsthecontinentsandwhereontherearenomile-stones.So,withthesextanthemadeobeisancetothesun-god,heconsultedancienttomesandtablesofmagiccharacters,mutteredprayersinastrangetonguethatsoundedlikeINDEXERRORPARALLAXREFRACTION,madecabalisticsignsonpaper,addedandcarriedone,andthen,onapieceofholyscriptcalledtheGrail—ImeantheChart—heplacedhisfingeronacertainspaceconspicuousforitsblanknessandsaid,“Hereweare.”Whenwelookedattheblankspaceandasked,“Andwhereisthat?”heansweredinthecipher-codeofthehigherpriesthood,“31-15-47north,133-5-30west.”Andwesaid“Oh,”andfeltmightysmall.
—JackLondon,TheCruiseoftheSnark
I. TheRiseandFallofr*andMonetaryPolicyNavigation
Thestabilizationofinflationandofthebusinesscyclearecoreobjectivesofa
centralbank.Rightfully,monetaryeconomicshasspentagreatdealofeffort
detailinghowpolicymakersshouldsetinterestratesastheystrivetoattainthese
objectivesinagivenenvironment.Yetenvironmentscanchange,andneithercentral
bankersnortheeconomicsystemexistinisolationfromoutsideinfluences.Inthis
paperweshowthatglobalforcessetthecourseofinterestratesoverthemediumto
longrun.Thishappenstoadegreeperhapsinsufficientlyappreciated.Navigating
policythroughtheeconomy’sstormywatersthereforerequiresagoodreadingof
localcurrentsasmuchasunderlyingyetpowerfulglobaldisturbances.
Specifically,weaddressbasicquestionsabouttheworkingsofmonetary
policywithevidencedrawnfromtherecenthistoryofadvancedeconomies.What
arethedriversofmonetarypolicyandhowshouldwemeasurethem?Howtruly
independentofeachotheraredifferentcentralbanks?Arethedriversdomesticor
international?Whataretheimplicationsofthismixofforcesformonetarypolicy?
Thekeyframinginourpaperisthedistinctionbetween,ontheonehand,
howcentralbankssteerbytighteningandlooseningtheirstanceinresponseto
2
localcyclicalmacroeconomicconditions;andontheotherhand,howwiderforces
canpermeateinterestratesettingsthroughthedriftofthenaturalrealrateof
interest,orr*,atbothlocalandgloballevels.
Tosharpenthedistinction:lookingonlytothenaturalrateforguidance
couldbereferredtoas“navigatingbythestars”(Powell2018),andwouldbeone
extremeapproachtopolicy;conversely,usingonlylocalcyclicalconditionsfor
pilotagewouldbeakintonavigatingbynearbyclueslikelandmarks,attheother
extreme.Asashorthand,letusrefertothesetwopolarextremesascelestial
navigationandterrestrialnavigation,respectively.Onemightthinkthatinreality
policymakerswouldrelyonbothguides,andindeedwewillarguethat,asan
empiricaldescriptionofreality,bothhavemattered.Ouranalysisthendocuments
therolesthateachhasplayed,theirrelativeimportance,andtheguidetheyprovide
tomacroeconomicoutcomes.
Thebackdroptoourdiscussionisarisingworryamongpolicymakersabout
there-emergenceofpolicydivergenceandwhatitportends.AftertheGlobal
FinancialCrisis,centralbanksinadvancedeconomiesloweredinterestrates
aggressivelyandendedupnearzero.Policywastunedtoadeeprecessioncontext
andthecommonnatureoftheshockpushedpolicystanceseverywhereintohigh
accommodation,albeitconstrainedbyaneffectivelowerbound.
Inthatmilieu,atfirstglance,policysynchronizationappearedtoreachan
extremenotseenforabout70years,goingbacktoasimilarconfigurationinthe
GreatDepressionofthe1930s.Yetthefailuretoseeautonomybeingused—inthe
senseofdivergentinterestratesettings—didnot,ofcourse,implythatautonomy
haddisappeared.When,inresponsetoasymmetricalrecoverypatterns,somebut
notallcentralbanksbegan“liftoff,”thistriggereddormantanxietiesaboutthe
negativespilloversandstressesthatnon-coordinatedpolicydivergencemightplace
uponthesystem.Asthetrilemmateachesus,whenautonomyiseventually
3
exercised,inaworldofcapitalmobilitythismustinevitablyperturbexchangerate
equilibrium.Butpoliticalrhetoricandeconomiclogiccanoftenpartways,andnow
talkofcurrencywarsandexchangeratemanipulationhasoncemorestartedto
makeheadlines.
Beyondalltheheat,canweshedlight?Withoutfirmerempiricalevidence,of
thekindwepresenthere,itisdifficulttoknowhowconcernedweshouldbe.And
thefactthatlong-runforcesmatter,thattheseforcesarebeyondpolicymakers’
control,andalsocontainastrongglobalcomponent,meansthatourargumentcould
supportamorebenignnarrative.
Theideathatmonetarypolicymakersareforcedtoadapttolong-runglobal
trendsasmuch,orevenmore,thanadjustingtoshort-runlocalstabilization
objectivesmayseemcontroversial—economically,aswellaspolitically.Intheory,
centralbankindependenceinsulatessocietiesfromshort-termpoliticsinfavorof
long-runwelfaregains.Indeed,centralbanksreadilyadmittotrading-offtheshort-
termforthelong-run.Yetfewwouldadmittrading-offdomesticinterestsforthose
abroad,evenwhendoingsomightbebetterinthelong-run.Politicsmattershere,
clearly.Butevenoneconomicgroundsthereis,atleastunderspecialconditions,a
theoreticalbasisforlookinginward,sinceincomplete,frictionlessinternational
assetmarketswithefficientrisksharing,centralbankscanachieveoptimal
stabilizationoutcomesbasedondomesticconsiderationsalone1.Butofcourse,the
worldismorecomplicated,andthatforcesustoconsiderhowandwhyitmatters.
Thequestionsathand—whatdrivesmonetarypolicy?andwheredowe
standnow?—canonlybeaddressedbyfirstsolvingtwoproblems.First,asa
conceptualmatter,ourpointofdeparturemustmakethecorrectdefinitionofterms
1SeethepapersofCorsetti,Dedola,andLeduc(2008;2010).Theformermakesthepointthatunderspecialconditions,globalconditionscanbeignored.Thelatterstressesthatmoregenerallythisisnotthecase,andwhatthenneedstobedonetoachieveanoptimalpolicy.
4
toproperlymeasuremonetarypolicystance,sincethiscanbetheonlybasisfor
soundanalysis.Second,asanempiricalmatter,wemustembracealong-termmulti-
countryperspectivetoproperlyjudgecurrentpolicyconditionsrelativetoa
sufficientlylargesampleofhistoricaloutcomes.
Wetaketheviewthatthestanceofmonetarypolicyisrigorouslydescribed
bythedeviationoftheprevailingpolicyrateorrelevantshort-termrealinterest
rate(r)fromthecorrespondingshort-termneutralorWickselliannaturalrealrate
(r*).Thekeychallengehereisthatthelatterisunobservable,yetsimplytousethe
formerwouldproducemismeasurement.Iftheneutralrateofinterestdeclines
fasterthanthecentralbankcutsnominalrates,financialconditionswillbetighter,
evenif,onthesurface,thecentralbankappearstobelooseningthem.Asweaimto
castbackoverseveraldecadesinthispaper,ourempiricalanalysisofthecauses
andconsequencesofmonetarypolicydivergencefirstrequiresplausibleestimates
ofthenaturalrateinmajoradvancedeconomiesandthisisamajortaskthat
occupiesusinthefirstpartofthepaper.
SectionIIleadsoffwiththeempiricalcoreofouranalysis.Itcentersonan
empirical,state-spacemodelofthenaturalratewhichbuildsontheseminalwork
donebyLaubachandWilliams(2003),andlatertakentointernationaldatain
Holston,Laubach,andWilliams(2017).Heretheapproachisaugmentedto
incorporateadditionalinformationfromyieldsonlong-termgovernmentbonds.In
thissetup,allbondyieldsincorporatethenaturalrealrateplusadditional
componentsreflectingtermpremiums.Wecanbetterpindownthecommontrend
inthebenchmarknaturalrateifweutilizemorethanonematurity,whileallowing
forthetermpremiumstovarybyperiodandbycountry.
Afterdescribingthisaugmentedmodel,wetheapplyittoapost-WW2
sampleofannualdataforfourmajoradvancedeconomies:theU.S.,Japan,Germany,
andtheU.K.Themodelproducessensibleandplausibleestimatesofthetwokey
5
latentstatevariables,thenaturalrateofinterestandthegrowthrateofpotential
output.Beyondthesewecanusethemodeltoconstructmanyimportantsummary
indicatorsforouranalysis.
Themodeloutputrevealsnew,interesting,andplausiblelong-runtrendsin
thenaturalrateintheadvancedeconomiesoverthelastsixtyyearswith
implicationsforwiderdebatesaboutthedriversofgrowthandthephenomenonof
secularstagnation.Laterinthepaper,whenwelookintomacroeconomic
adjustment,welettheseestimatesspeaktothemechanicsofcelestialnavigation.
Wecanobtainthemeasureofmonetarypolicy,orstance(actualshortrateminus
naturalrate),andhowfartheeconomyisfromitspotential,orgap(actualminus
potentialoutput).Laterinthepaperwelettheseestimatesspeaktothemechanics
ofterrestrialnavigation.
InSectionsIIIandIV,wetakethemodelestimatesandconstructtheanalytic
narrative.Hereweaimtodevelopaquantitativeinterpretationofthepostwar
historyofmonetarypolicymakinginthefourmajoradvancedeconomies.We
presentmanyfindings.
From1985,andforthelast30years,wefindacommon,decliningr*inall
countries;previouslyr*hadbeenrising,especiallyinthe1970s.Thefindingisnot
newinitself,butnowconfirmedeveninamodelwithtermpremiums.Wefindthat
alleconomieshaveastrongcommonglobalcomponentintheirr*measure.They
alsohaveastrongcommonglobalcomponentintwosubcomponentsofr*.Thefirst
oftheseisattributabletopotentialoutputgrowthandthesecondcapturesother
latentfactors.Eachexplainsabouthalftheglobalvariationinr*.Thetermpremiums
varymuchlessandhavebeenrelativelystableinthelast30yearsorso.
Wefindthatalleconomieshaveastrongcommonglobalcomponentintheir
outputgapmeasuregap.Theyalsohaveastrongcommonglobalcomponentintheir
policymeasurestance.Despitethefocusofmuchempiricalandtheoreticalworkon
6
thelocaleconomydeterminantsofstance,wefindthatmostofthevariationinshort
ratesisnotaccountedforbystanceatall.Rather,overthelongrun,variationinthe
localandworldpathsofthenaturalrateisconsiderable.Wefindacross-country
convergenceofbothgapandstance,whichhaveseenfallingdispersionsince1970.
Butforstancethiswasnotmonotonic,aspolicydispersionrosetohighlevelsfrom
thelate1970stotheearly1990s.Thisisintuitive,giventhechaoticnatureof
monetarypolicyexecutionfromthecollapseforBrettonWoodstothestartof
inflationtargeting.
SectionVtheninvestigatesthepredictivevalueofthemodelestimatesfor
keyshort-runlocalmacroeconomicoutcomesandaskswhethertheseaccordwith
conventionalwisdom.Thedynamicsofgapandstanceareintuitiveandplausible.A
positivechangeinstancepredictsanegativechangeingap:atighterpolicytendsto
leadanoutputslowdown.Apositivechangeingappredictsapositivechangein
stance:anoutputaccelerationtendstoleadatighterpolicy.
Lastly,SectionVIinvestigatesthepredictivevalueofthemodelestimatesfor
arangeofmedium-runopen-economymacroeconomicoutcomesandaskswhether
thesealsoaccordwithconventionalwisdom.Here,wetrytoassesswhetherthe
inferredmeasuresoftheneutralrealrater*fromthestate-spaceestimationalign
withtextbookdescriptionsontheworkingsoftheinternationaladjustment
mechanisms.Thisbroadcross-checkonthewhetherthemodelmakessenseproves
encouragingandwefindthat,basedonthedifferentialbetweenthecountyr*and
theworldr*,ahigherrelativelocalr*todayisassociatedsubsequently,overthe
medium-termhorizon,withhigheroutputrelativetopotential;higherinflation
relativetosteadystate;atighterpolicystance;astrongerexchangerate;alarger
currentaccountdeficit;alowersavingrate;ahigherinvestmentrate;andstronger
growthinrealcreditcreation.Alltheseresponsesaccordwellwithstandard
7
economiclogicinanopeneconomysettingwithdivergentnaturalrealratesand
adjustmentfrictions(Clarida2019;Obstfeld2019).
SectionVIIconcludeswiththepolicyimplicationsofouranalysis.Briefly,ina
financiallyintegratedworldwherecapitalcanmovefreelyacrossborderswith
increasingease,centralbanksshouldtackinresponsetolocalconditionswhileat
thesametimeobservingthedriftofeconomiccurrentsimpliedbydisturbancesin
theneutralratenearandfar.Ignoringsuchtrendsrisksprovokinginternaland
externalimbalances,aswellasunwanteddislocationincreditmarkets,eventually
carryingtheeconomyoffcourse.
II. DescriptionoftheModel
TheWickselliannaturalrateofinterestisayardstickforthestanceof
monetarypolicy.AlthoughWicksell(1936[1898])initiallydefinedthenaturalor
neutralrateasashort-terminterestratethatkeepsoutputatitspotentialleveland
pricesstable,numerousrefinementshaveemergedsinceWoodford’s(2003)
influentialtextbookandLaubachandWilliams’(2003)estimates,withsome
divergenceemergingbetweenshort-andlong-runversionsofthenaturalratein
subsequentworkbyothers.
Theapproachthatwetakeispragmatic.CastagainstacanonicalNew
Keynesianmodel,ourestimateofthenaturalrateispinneddownbyboththeIS
curve,whichspellsouttherelationshipbetweenoutputgapsanddeviationsofthe
realratefromitsnaturalrate,andthePhillipscurve,whichthenrelatesinflationto
pastandfutureexpectedinflationandtheoutputgap.Inthelongrun,thenatural
rateensuresthatoutputisatpotentialand,hence,thegrowthrateofpotential
outputisakeydeterminantofthenaturalrate.Ouraugmentedmodelalsoviews
8
longtermbondyieldsasbeingdeterminedbythenaturalrate,inflation
expectations,andatermpremium.
Theessentialproblemisthatthenaturalrateisnotdirectlyobservableand
neitherareseveralofthekeyvariables.Henceourmodelcontainsseveral
unobservedlatentprocessesorstatevariablesthathavetobeestimatedvia
MaximumLikelihoodmethodsthroughaspecificationofthecorrespondingstate-
spacerepresentationandusingtheKalmanfilter.
Ourmodelcanbesummarizedbythefollowingequations,organizedby
block.Webeginwiththesetofequationswhichdescribethestochasticprocessfor
potentialoutputandhenceitsrateofgrowth.Let𝑦"denote100timesthelogofreal
GDP,and𝑦"∗denote100timesthelogofpotentialrealGDP,treatedasan
unobservedstatevariable.Thelatterhasafirstdifferencedenotedby𝑔" ,alsoan
unobservedstatevariableassumedtofollowarandomwalk.Finally,let𝑥"denote
theoutputgap,withanalogouslogscaling,definedasthedifferencebetweenactual
andpotentialoutput.Thespecificationofthisblockofequationsisthesameasthat
inLaubachandWilliams(2003)andusedinsubsequentresearchbymanyothers.
Summarizing,potentialoutputanditsgrowthratearedeterminedbythefollowing
expressions,
𝑦"∗ ≡ 𝑦"'(∗ + 𝑔", (1)
𝑔" = 𝑔"'( + 𝑣",, (2)
𝑥" ≡ 𝑦" − 𝑦"∗. (3)
Wenowlet𝑟"denotetheex-anterealrateonshort-termgovernmentbills,
specifically,𝑟" = 𝑖" −𝜋"|"'(∗ .Andlet𝑟"∗denotetheassociatedneutralrealrateof
interestforthisasset.WespecifytheIScurverelatingtheoutputgaptothelagged
9
outputgapanddeviationsoftherealratefromitsneutrallevel,plusanerrorterm,
suchthat
𝑥" = 𝜙𝑥"'( − 𝛾(𝑟"'( − 𝑟"'(∗ ) + 𝑣"8, (4)
where𝜙, 𝛾 > 0.Tosimplifythemodel,andforsymmetrywithrespecttosubsequent
expressions,werestrict𝜙 = 0.65butleave𝛾otherwiseunrestricted.
Theneutralrateofinterestisassumedtobedeterminedbythesumoftwo
components,alatenttrendfactor𝑧"andthegrowthrateofpotentialoutputdefined
earlieras𝑔" .Thisspecificationofthestochasticprocessoftheneutralratealso
borrowsfromLaubachandWilliams(2003),andimpliesthat
𝑧" = 𝑧"'( + 𝑣"?, (5)
𝑟"∗ = 𝑧" + 𝑔" . (6)
Thelatenttrendfactor𝑧"capturesallotherinfluencesonthenaturalrateotherthan
growth,suchasdemographics,financialliberalization,fiscalpolicy,andsoon.2
Wenextturntoinflation,where𝜋"denotesthefirstdifferenceof100times
thelogofthepricelevel.InflationisassumedtobedrivenbyahybridPhillipscurve
thatdependsonpastinflationandexpectationsoffutureinflation,inadditionto
fluctuationsintheoutputgap,plusanerrorterm.Thissetupcanbederivedfrom
firstprinciples,forexample,asintheGalí(2015)textbook.WespecifythePhillips
curvehereas
𝜋" = 𝛼𝜋"'( + (1 − 𝛼)𝜋"|"'(∗ + 𝛿𝑥"'( + 𝜖"D , (7)
whereweassumethatagentsplaceequalweightonthelaggedandexpectations
termsandhence𝛼 = 0.65.Thisassumptionisconsistentwithcommonestimates
summarized,forexample,inJordàandNechio(2018).Notethat𝜋"|"'(∗ denotes
2See,e.g.,Carvahlo,FerreroandNechio(2016)ondemographics,andRachelandSummers(2019)onfiscalpolicy.
10
expectedinflation,whichweassumeisobtainedfromalatenttrendinflation
processoftheform
𝜋"∗ = 𝜋"'(∗ + 𝑣"D∗. (8)
Recently,credibleinflationtargetingbycentralbanksmightseemtodirectly
provideuswithavaluefor𝜋"∗.However,overafullpost-WorldWarIIsamplesuch
asours,underlyinginflationtrendsexperiencedconsiderablevariability.Theabove
equationwillallowenoughflexibilityforthemodeltotrackthesetrends.
Thefinalpairofequationscharacterizesthenominalinterestrateoryieldon
safeassets,theshortbillandthelongbond,denoted𝑖"E ,where𝑗 = 𝑏, 𝐵referstobills
andbonds,respectively.Theseareassumedtobepersistentandfollowasimple
errorcorrectionmechanismwheretheequilibriumvalueisdeterminedbythereal
neutralrateofinterest,plusinflationexpectations,plusatime-varying,yield
premiumforthelongbond,𝜂"J ,pluswhite-noiseerrorterm.Thesuperscript𝑗here
denotesthespecificassetclass,sothatthestochasticprocessisspecifiedas
𝑖"E = 𝜌EL𝑟"∗ + 𝜋"|"'(∗ + 𝜂"
EM + L1 − 𝜌EM𝑖"'(E + 𝜖"
E, (9)
with𝜌E = 0.65chosenconsistentwithpreviousexpressions,andwherej=b,B,and
𝜂"N=0byassumption.HereBreferstolong-termgovernmentbonds(approximately
10-yearduration);andbreferstoashort-termtreasurybill(3-month).Notethat
fromtheex-postrealbillrate𝑟"wecanconstructtheerrorcorrectionmechanism
forthenominalrateusingourestimatesof𝑟"∗and𝜋"|"'(∗ .Furthermore,theterm
premiumforbondsisassumedtofollowalatenttrendprocesscharacterizedby
𝜂"J = 𝜂"'(J + 𝑣"J . (10)
Summingup,theerrorterms𝑣"Oareassociatedwiththestatevariables,
wherethesuperscriptℎ = 𝑔, 𝑧, 𝑥, 𝜋∗, 𝐵.Theerrorterms𝜖"Q areassociatedwiththe
observedvariables,sothat𝑘 = 𝜋, 𝑏, 𝐵.Andallothervariablesareasdefinedearlier.
11
Notethatourapproachexplicitlydoesnotimposeapolicyruleaspartofthe
estimationprocedure,e.g.aTaylorRule.Thisispragmaticgiventhatoursample
windowincludeseraswithverydifferentmonetaryregimes,withinandacross
countries—forexample,centralbanksattimestargetedtheexchangerate,atother
timesinflationoreconomicactivity.Instead,weremainagnosticandinformally
examinethedynamicsofpolicystanceandtheoutputgaplateron.
ThemodelisestimatedbyMaximumLikelihoodusingtheKalmanFilterand
theconstraintsdescribedaboveforeachcountryindividually:Germany,Japan,the
U.K.,andtheU.S.fortheperiod1955to2018.Weemploypost-WW2annualdata
takenfromtheJordà,Schularick,andTaylormacrohistorydatabase
(www.macrohistory.org/data)anddevelopedinJordà,Schularick,andTaylor
(2017)andJordà,Knoll,Kuvshinov,Schularick,andTaylor(2019),andwherewe
extendtheseriesforwardfrom2015usingstandardsources.
III. CommonShocks,CommonTrends
Themodeldeliversanumberofinterestingempiricalresultsthatwe
examineinmoredetailinthenexttwosections.Inparticular,wefirstconfirmthe
well-knowndeclineinthenaturalrateinthepast30years(e.g.,KingandLow2014;
RachelandSmith2015;Holston,Laubach,andWilliams2017;RachelandSummers
2019).Thisdeclinediffersfromtherecentbehaviorofequityandbondreturns,an
issuetheliteratureisstillgrapplingwithandwhichwedonotexplorehere.Wealso
find,relativetothenaturalrate,afairlystabletermpremiuminthelongbondyield.
Wethenshowthatthereisastrongcommoncomponentinthedeclineofthe
neutralratethatisnotexplainedjustbygeneralizeddeclinesinthegrowthrateof
potential,andwhichcouldbeduetodemographic,productivity,orotherfactorsthat
12
wedonotdirectlyexploreinthispaper(seeRachelandSmith2015foran
assessmentofpotentialexplanations).
III.A)Theriseandfallof𝒓∗andtheevolutionofthetermpremium
ThekeyoutputfromthestatespacemodelispresentedinChart1.The
figurescoverthefourmajoradvancedeconomiesandtheyears1955to2018.Four
seriesareshown,twooneachpage.OnpagesoneandtwoofChart1,oneofthe
seriesisrawdata,namelytherealbillrate,definedastheshorttermbillrateminus
expectedtrendinflation,𝜋"|"'(∗ ,whichiswhatwedefinedastheex-anterealrater.
Theotheristhecorrespondinglatentstatevariableestimatedinthemodel,thereal
naturalrater*.Therealnaturalrateforthefourcountriesdisplaysastriking
commonpatternovermostofthesample.Itreachesalocalmaximumaround400–
500bpsinthe1980sandaglobalminimumaroundminus100–200bpsinthelast
decade.ThemainoutlierisJapan,whichbrieflyhasanevenhigherestimated
naturalrateinthe1950s,andwhichthendropsquicklyupto1970.
Fortheothercountriesthenaturalratestartslow,nearzero,andthenforall
fourcountriesthenaturalrateincreasessharplyfromthe1970stothe1980s.Inall
casesthepathofthenaturalratebroadlytracksthepathoftheshort-termrealbill
rate,butdoessoalongamuchsmootherpath,asisexpectedgiventheparameters
ofthestate-spacemodel.
OnpagesthreeandfourofChart1,oneoftheseriesisrawdata,namelythe
observedtermpremiumorslope,definedasthelongterm(10-year)bondyield
minustheshort-term(3-month)billyield.Theotheristhelatentstatevariable𝜂"J
estimatedinthemodel,correspondingtothelowfrequencyvariationintheslope,
whichwemayalsodenoteslope*.Themagnitudeofthevariationinslope*is
noticeablysmallerthanthatseeninr*,witharangeofabout200–300bpsversus
400–600bps.
13
Chart1Estimatesofr*and𝜼𝒕𝑩versusactualrealshortrateandslope
-20
24
68
perc
ent
1955 1965 1975 1985 1995 2005 2015
USA-2
02
46
8pe
rcen
t
1955 1965 1975 1985 1995 2005 2015
JPN
r-star, real
short rate, real
14
Chart1Estimatesofr*and𝜼𝒕𝑩versusactualrealshortrateandslope(continued)
Notes:Author’scalculations.Seetext.
-20
24
68
perc
ent
1955 1965 1975 1985 1995 2005 2015
DEU-2
02
46
8pe
rcen
t
1955 1965 1975 1985 1995 2005 2015
GBR
r-star, real
short rate, real
15
Chart1Estimatesofr*and𝜼𝒕𝑩versusactualrealshortrateandslope(continued)
Notes:Author’scalculations.Seetext.
-6-4
-20
24
perc
ent
1955 1965 1975 1985 1995 2005 2015
USA-6
-4-2
02
4pe
rcen
t
1955 1965 1975 1985 1995 2005 2015
JPN
slope-star
slope, 10Y minus 3M
16
Chart1Estimatesofr*and𝜼𝒕𝑩versusactualrealshortrateandslope(continued)
Notes:Author’scalculations.Seetext.
-4-2
02
4pe
rcen
t
1955 1965 1975 1985 1995 2005 2015
DEU-4
-20
24
perc
ent
1955 1965 1975 1985 1995 2005 2015
GBR
slope-star
slope, 10Y minus 3M
17
Thepatternsarealsolessclearintermsofdirection.Slopehasrisenover
timeinU.S.,U.K.,andJapan,hasdrifteddowninGermany,andbeenquitevolatilein
theU.K.Specifically,since1980,theerainwhichestimatesofr*basedonshortrates
havecollapseddramaticallybyseveralhundredbasispoints,weseelittlesignthat
anystronglydifferenttrendhasbeenseenatthelongendoftheyieldcurve.
III.B)Decomposingthedriversof𝒓∗
Thestate-spacemodelalsopermitsustolookunderthehoodandexplore
thedriversoftheshiftsintherealnaturalrate.Equation(6)statesthat𝑟"∗ = 𝑧" + 𝑔" ,
sotherealnaturalrateisthesumofthelatenttrendfactor𝑧"andthegrowthrateof
potentialoutput.Chart2displaysthisdecompositionforthefoureconomies.Again,
someverybroadcommonalitiesintrendsstandout,afterwelookpastthehigh-
frequencychanges.Theriseandfallofthenaturalrateisnowseentobethe
combinationoftwopatternswhicharesuperimposed,oneadowntrend,theother
aninverse-Utrend.
Thefirstpatternwecanmakeoutisthegradualseculardowntrendinthe
growthcomponent𝑔" ,whichhasbeenaglobalfactorcommontoalloftheadvanced
economiesinthepost-WW2period.Thisdowntrend,asexpected,wasstrongestin
JapanandGermany,wheretheimmediatepostwargrowthsurgeshadbeenthe
mostrapid.IntheU.S.andBritain,thedowntrendwasmoregradual.Thesecond
patternistheriseandfallofthelatentfactor𝑧" ,whichcapturesallothersecular
changesinthenon–growthrelateddriversofthenaturalrateinthisperiod,suchas,
thewell-documentedgreyingofthepopulationandthelargefiscalconsolidation
post-WW2.ThesefactorsinteractwitheachothertoproducetheinvertedU-shape
thatwereport.Thelatentfactorrises400–500bpsuptothe1980s,beforeturning
aroundand,inallcasesbarJapan,retracingtosomethingclosetoitsformerlevelby
now.
18
Chart2Thenaturalrater*,growthcomponentg,andlatentfactorz
Notes:Author’scalculations.Seetext.
-50
510
perc
ent
1955 1965 1975 1985 1995 2005 2015
USA-5
05
10pe
rcen
t
1955 1965 1975 1985 1995 2005 2015
JPN
natural rate (r*), real latent component (z), real
growth component (g), real
19
Chart2Thenaturalrater*,growthcomponentg,andlatentfactorz(continued)
Notes:Author’scalculations.Seetext.
-50
510
perc
ent
1955 1965 1975 1985 1995 2005 2015
DEU-5
05
10pe
rcen
t
1955 1965 1975 1985 1995 2005 2015
GBR
natural rate (r*), real latent component (z), real
growth component (g), real
20
Summingup,thenaturalratereachedalocalpeakaround500bps(±100
bps)inthemid-1980s,maybealittlelowerataround300bpsinJapan.Sincethen,it
hasfallengraduallytolevelsintherange–100bpsto0bpstoday,reachingminima
evenfurtherbelowzerointheyearsrightaftertheGlobalFinancialCrisis.Inall
countriesthelong-rundeclineisdrivenbyacombinationofdropsinpotential
growthrateandtheriseandfallofthelatentfactor.
III.C)Localversusglobalr*
Todigmoredeeplyintotrendsinthenaturalratewetakeacloserlookatthe
relationshipbetweenthe“local”country-specificmeasuresofthenaturalrateand
itscomponents,ascomparedtoa“global”four-countryaveragemeasure.Chart3
presentstheglobalmeasuresofthenaturalrate,thegrowthcomponent,andthe
latentfactorcomponent.Itsummarizesthecommonpatternsjustnoted.Thereisa
long-runriseandfallinthenaturalrate,withapeaknear400bpsinthe1980sand
aminimumnearminus100bpstoday.Thisistheresultofasteadydeclineinthe
growthcomponentoversixdecadescombinedwithanincreaseinthelatentfactor
inthe1960sand1970sfollowedbyareversal.
Chart4nextlooksathowcloselyeachcountry-specifictrendtracksthe
globalpattern,fortherealnaturalrateanditstwocomponents.Overall,theanswer
isthatthelocalandglobalelementsmoveverymuchinsyncwitheachother,with
theanticipatedexceptionbeingJapanduringthefirst10–15yearsofthesample
window,asnotedearlier.Astothecauseofthistightco-movement,thesepatterns
couldemergefromcommonshiftsacrosscountriesingrowth,indemographics,or
infinancialliberalization;theycouldalsoderivefrominternationalarbitrage;or
indeedfromacombinationofsomeoralltheseforces,dependingontheera.
21
Chart3Globalr*andcomponents
Notes:Author’scalculations.Seetext.
-4-2
02
46
perc
ent
1955 1965 1975 1985 1995 2005 2015
global av. natural rate (r*), real global av. latent component (z), real
global av. growth component (g), real
Global r*, g, z
22
Chart4Localversusglobalr*andcomponents
Notes:Author’scalculations.Seetext.
-20
24
6pe
rcen
t
1955 1965 1975 1985 1995 2005 2015
(a) Global v local r*-6
-4-2
02
4pe
rcen
t
1955 1965 1975 1985 1995 2005 2015
(b) Global v local z component
02
46
810
perc
ent
1955 1965 1975 1985 1995 2005 2015
(c) Global v local g component
global average USA GBR
JPN DEU
23
Alongersweepoffinancialhistorysetsthepost-WW2recordofthenatural
rateinabroadercontext.Despitemuchwringingofhandsaboutthethree-decade
declineinthenaturalrate,Jordà,Knoll,Kuvshinov,Schularick,andTaylor(2019)
showthatlowrealratesofreturninsafeassetclassesoccupylongstretchesoftime
historically,inamannerconsistentwithalowneutralrealrateofinterest.If
anything,itisthentherelativelyhighlevelsoftherealinterestratesexperiencedin
the1980s,theverynoticeablepeakseenhereandinotherrecentstudies,which
standoutmoreastheexceptionthantherule.
IV. “Terrestrial”versus“Celestial”Navigation:ChartingtheCourseofMonetaryPolicy
Thediscussionsofarhasemphasizedaprimaryoutputofthemodel,the
naturalrealrate.Thisvariablehasbeenthefocusofthemanyanalysesusingthese
kindsofstate-spacemodels.Butthisisnotouronlyfocus,sincethemodelalso
generatesotherestimatesofgreatinterestwhichshouldprovideinsightsintothe
driversofpolicy,localmacroeconomicdynamics,andinternationaladjustment.In
thelasttwosectionsofthispaper,weturntoanexaminationofthesefeatures,to
seeifthemodelsshedlightonsomeofthecentralpolicyquestionsoftheday.
Toframethediscussion,itisworthemphasizinghowthemodelallowsusto
decomposelocalmonetarypolicysettingsintothreedistinctcomponents.Wehave
alreadydiscussedthe“global”factorofthenaturalrate,whatwenowrefertoasthe
“worldlevel”ofr*,whichweshalldenote𝑟W∗ .Withoutlossofgenerality,onecan
writethelocalshort-terminterestrateinanyeconomyasthesumofthreeterms:
𝑟" = L𝑟" −𝑟"∗MXYYZYY[\]^_`ab_
cd`^ca`d_def
+ L𝑟"∗ − 𝑟W,"∗ MXYYYZYYY[
gd`^ceb_hijdkcl_^]hk^ck^]a
+ 𝑟W,"∗m
ndkcl_^]hk^ck^]a
. (11)
24
Ofcourse,inthisframework,fromthepointofviewofthelocalpolicymaker
onlythefirstoftheseterms,stance,isundertheircontrol.Incontrast,thelasttwo
terms,thepathoflocaleconomy’snaturalrateanditsdeviationfromtheworld
average,aretakenasgivenbythepolicymaker.3Thedecompositioninexpression
(11)providesausefulsextantwithwhichtomeasurewhatfactorshaveinfactbeen
drivingmonetarypolicy,andespeciallyhowmuchofarolethe“star”termsplay.
Weembraceacrudedichotomy.Underwhatwemaytermtheterrestrial
navigationview,policymakershavetheirheadsdown.Intheshort-run,thestars
don’tmovemuch.Witheyesmainlyontheground,policymakersareguidedbythe
locallandmarksofoutputgapsandinflationgapsandsetstanceaccordingly,
ignoringthelocalandglobalstarterms.Here,itisstanceasmeasuredbythefirst
termin(11)thatmattersmost.
Afocusonstanceasthekeydriverofmonetarypolicysettingunderpins,for
example,thebenchmarkempiricalmodelsofinterest-raterules(e.g.,J.Taylor
1993),andthecanonicaltheorywhichrationalizesthem(e.g.,Woodford2003).In
baselineversions,thepolicyruleinterceptisconstant,andbyconstruction
variationsinthenaturalrateplayvirtuallynorole,averystrongassumptionbut
onethatisoccasionallyputforwardallthesame(Wieland2018).Thisviewis
soundlyrejectedbythedatainourmodel.Ourtime-varyingneutralrateis
impreciselyestimated,butitresultsinavastimprovementoftheloglikelihood
relativetothatofamodelthatpermitsforonlysmallfluctuationsoftheneutralreal
ratearoundaconstant.Wemightsaythatthestarshavestatisticalsignificance.
Next,consideracelestialnavigationview,wherepolicymakerswouldexpand
thehorizonandwouldconsidernotsimplythefirstterminexpression(11)butthe
roleplayedbythelattertwotermsaswell.Thestarsaremovingandmustbe
3Thoughsomewouldgosofarasviewingthenaturalrateasendogenoustomonetarypolicy.SeeBorioetal.(2018).
25
trackedlestundesirabledeviationsinthepolicypathaccumulateandtakeusoff
course.IntheterminologyofPowell(2018),policymakersarenotfixatedonlyon
locallandmarks,buttakeintoaccountthestars—thatis,thelocalandworldnatural
rates.Thisisakeyaugmentationtothestandardmodelsandtheories,andithas
beenemphasizedbyalongliteraturesinceLaubachandWilliams(2003).
Indeed,wewillfindthatmostofthevariationinthepolicysettings,as
measuredbyinterestratesattheshortend,isdrivennotbythepathofthestance
termbutratherbychangesinthepathsoflocalr*andworldr*termsinequation
(11).Inthissense,interestratesettingisdrivenbyfactorsoutsidepolicymakers’
control.Takingthelongview,thecelestialmattersasmuchifnotmorethanthe
terrestrial.Thestarsalsohavequantitativesignificance.
IV.A)Lookingtothestars:Variancedecompositionofinterestrates
Arecentralbankersstargazersorshoegazers?Thisisanempiricalquestion,
andourstatespacemodelcombinedwiththeabovedecompositiongivesusan
opportunitytoputtoatesttheterrestrialandcelestialnavigationviews.Wetakea
simpleapproach.Wecomputealltermsinequation(11)forourfullsampleandfor
allfoureconomies.Wethencalculatethevarianceoftheleft-handside,andthe
varianceofthethreetermsontheright-handside,plusaresidualtermwhich
accountsforcovariancecomponents.TheresultsareshowninChart5,forthefull
sampleofallyears,andthreesubsampleperiods,andprovideaveryclearanswer.
Thefigureshowsthevarianceofthefirstterm,representingstance,inblue
shadedbars.Inallyearsthistermaccountsforatmostabout40%ofthetotal
varianceintheshortrate.Bycomparison,theothertwoterms,the“star”terms,
whosevarianceisdepictedbytheredandorangebars,accountforalmostallofthe
remaining60%ofthevarianceintheshortrates.
26
Chart5Variancedecompositionofrealshort-terminterestratesoverfivedecades
Notes:Author’scalculations.Seetext.Otherreferstotheresidualduetocovarianceterms.
Therevariationbysubperiod,butnotsomuchastooverturnthebasicpoint.
Stancevariationexplainsagreatershareduringthemiddleperiodofmoreerratic
monetarypolicyfromthecollapseofBrettonWoods(1974)totheeraofinflation
targeting(1994).Notsurprisingly,themoremonetarypolicyisrudderless,inthis
setup,thegreateractionwillbeattributedtotheuseoflocalguidance(evenifitis
poorguidance)thantotheslow-movingnaturalratecomponents.
Summingup,usingourempiricalapproach,postwarhistoryoffersavery
definitivejudgementontheterrestrialversuscelestialdebate.Localandworld
naturalratesarenotconstant,andtheirineluctabledriftpullsonthecoursesettings
ofmonetarypolicymakers,perhapsmorethanhasbeenyetrealized.Overfive
decades,amajorityofshort-ratevariationhasbeendrivenbythesestarfactors,and
lessthanhalfbychangesintheresidualstancemeasure.
01
23
45
1955–1974 1975–1994 1994–2015 All years
r – r* r* – r*wr*w other
27
Butthisvariancedecompositionisonlyastartingpointforouranalysis.We
candomuchmorewiththedecompositioninequation(11),andtherestofthe
papercarriesthisforwardinseveraldirections.Inthelastpartofthissectionwe
lookatthetimevariationinthedispersionofstanceandhowitrelatestotime
variationinthedispersionoftherealfundamental,theoutputgap.Theuneven
historicalpatternswefindareilluminating.Thenintheremainderofthepaperwe
lookatthestanceandstartermsandstudytheircontributiontomacroeconomic
adjustmentdynamics.Providingafurthercross-checkonourmodeloutput,this
exerciseshowsthatbothsetsoftermsgenerateadjustmentpredictionsthatalign
withtextbookmacroeconomicintuition.
IV.B)Steeringinerraticcurrents:comparingtheevolutionofmonetarypolicystanceandtheoutputgapoverfivedecades
Inlightoftheabovedecomposition,andasasensecheck,considerthe
evolutionofstanceandgapinthefourcountriessince1960,discardingtheprior
fiveyearsastrainingdataforthemodelgiventheapparentinstabilityofsome
estimatesinthoseyears.
Chart6presentsovertwopagesdescriptivesummariesofthemodel
estimates.Fornow,wewillfocusonthefiguresinthefirstandsecondrowsofeach
page,referringtogapandstance.Wewilldiscussinflationdispersionbehavior,
describedbythefiguresinthethirdrow,inamoment.Thefiguresonpageone
showtheaveragelevelsofstanceandgapinthefour-countrysample,alongwithan
indicationofthemin-maxrangeineachyeartoshowthedispersion.Analternative
measureofdispersionisshownonpagetwo,thestandarddeviationofgapand
stance,byyear,withanonparametricestimatedtrendbasedonakernelregression
alsoshown.
28
Chart6Dispersionofmonetarypolicystance,outputgap,andinflation
Notes:Author’scalculations.Seetext.Smoothedestimatesinlowerpaneluseabandwidthof8years.
-4-2
02
4
1960 1970 1980 1990 2000 2010 2020
(a) Gap levels-4
-20
24
1960 1970 1980 1990 2000 2010 2020
(b) Stance levels
05
1015
20
1960 1970 1980 1990 2000 2010 2020
(c) Inflation levels
min/maxaverage
29
Chart6Dispersionofmonetarypolicystance,outputgap,andinflation(continued)
Notes:Author’scalculations.Seetext.Smoothedestimatesinlowerpaneluseabandwidthof8years.
0.5
1
1960 1970 1980 1990 2000 2010
(d) Gap dispersion0
.51
1.5
22.
5
1960 1970 1980 1990 2000 2010
(e) Stance dispersion
02
46
1960 1970 1980 1990 2000 2010
(f) Inflation dispersion
sdsmooth line of estimates
30
Thesefiguressummarizetwoimportantbutcontrastingtrendsinthekey
model-impliedstatevariables,stanceandgap,inthelastsixtyyears.Withrespectto
gap,thecross-countrydispersionhasseenonalong,gradual,monotonicdownward
trendforthelastsixdecades,allowingforsomeshort-runvolatilityalongtheway.
Thebusinesscyclesofthefoureconomieshavesteadilymovedintogreater
synchronizationovertime.Thishappenedevenaspotentialoutputfollowedrather
differentpaths(JapanversustheU.S.,forexample).Itisastrikingfeatureand,a
priori,itisnotobviouswhythiswouldbeso.Lookingatthetrend,gapdispersionis
nowatabouthalfofitslevelin1960.Evenintheabsenceofexplicitmonetarypolicy
coordination,andinlightofthisdegreeofbusinesscyclesynchronization,one
wouldexpectmonetarypolicystancetobesimilarlysynchronized.
However,thisdoesnotappeartobequitethecase.Thetrendishump
shaped.Forthefirsttwoorthreedecades,evenastherealeconomiesbecamemore
aligned,monetarypolicystancegotevermoredivergentintheseeconomies.The
findingisintuitiveandfitsthehistoricalnarrative:withBrettonWoodsfallingapart,
centralbanksgropedforanewnominalanchor,buttheyblunderedaboutfor10or
20yearsbeforetheyallcoalescedonanewinflation-targetingconsensus,andthat
newpolicyregimeeventuallybroughtstancedispersionmorecloselybackintoline
withgapdispersion.
Thedispersioninoutputgapshasbeendecliningthroughoutthepost-WW2
era,evenbeforethestartoftheperiodcommonlyreferredastheGreatModeration.
Interestingly,thedispersioninmonetarypolicystances,measuredasthedeviation
oftherealratefromtheneutralrate,doesnotquitefitthesamepattern.Today
stancedispersionisalsoataboutonehalfofitslevelin1960,butittookamuch
moreinterestingjourneyalongtheway.Butasofnow,fromtheperspectiveofthe
fullpost-WW2experience,thecurrentobserveddivergenceinstanceappearswell
withinthehistoricalnorm.
31
ThisnarrativeisconsistentwiththefinalrowoffiguresinChart6.Whilegap
dispersionwasfallinginamoreorlessstraightline,thecentralbanksinoursample
lostcontrolofinflationinthe1970s,togreaterorlesserdegrees.Onecouldsaythat
themistakesderivedfromlargeshiftsinpolicystanceasinflationcontrolwentout
ofkilter,andthecorrectionofthemistakessubsequentlyallowedaconquestof
inflationglobally,butthisrequiredfurtherlargeshiftsinpolicystance,toget
inflationcontrolbackontrack.Thus,stanceandinflationleftaveryvolatile
signatureintheserecordsinthemiddleyears,evenasrealsidevolatilityduetogap
followedacalmandgradualdescentfromstarttoend.
V. PolicyStance,theBusinessCycle,andDomesticAdjustment
Inthissection,wewillfirstexplorewhatthemodeloutputshavetosayabout
standardtheoriesofthedomesticco-evolutionofthefirsttermabove,
𝑠𝑡𝑎𝑛𝑐𝑒" ≡ 𝑟" −𝑟"∗,anditsnaturalco-statevariable,𝑔𝑎𝑝" ≡ 𝑥" ≡ 𝑦" − 𝑦"∗,which
measuresthedistancebetweenactualandpotentialoutput.Inthenextsectionwe
askhowthefirstterm,thedifferentialbetweenlocalandworldnaturalratesrelates
totheoriesoftheinternationaladjustmentprocess.Tostart,asimpleGranger
causalityapproachconfirmsintuitionabouthowpolicyaffectsthestateofthe
economy,andhowpolicyisinturninfluencedbythestateoftheeconomy.
V.A)Thedynamicsofstanceandgap
Giventhemodelimpliedstanceandgapmeasures,weinvestigatetheirco-
evolutioninasmall-scaleestimateddynamicalsystem.Weestimatereduced-form
localprojectionsoffuturecumulativechangesinavector∆O 𝒚x," = 𝒚x,"yO − 𝒚x,"'(,
wherethevectorelementsare𝒚={stance,gap},andoutcomesarechangesfrom
year𝑡 − 1to𝑡 + ℎ,regressedonobservedchangesinstanceandgapinyeart,
32
denoted∆𝒚x," ,plus2lagsofthestatevectorasadditionalcontrols𝒙x," .Estimationof
eachequationisbypanelOLSwithcountryfixedeffects.
Dothesepredictiveestimatesaccordwithintuition?Table1suggeststhat
theydo.Panel(a)displaystheresponseofstancetogapandtoitself.Theresponse
ofstancetogapissignificantattheone-andtwo-yearhorizonsandhasthe
expectedpositivesign.Anincreaseingap,i.e.,amorerapidlygrowingeconomy,
predictsatighterpolicystanceoneyearahead.Beyondoneyearallestimatesare
small.Theownresponseofstancetoitselfismoderatelypersistent,butalsohasthe
expectedsign.Afteroneyearabout60%ofthechangeinstancepersists,thelargest
responsecoefficientofthefour.Infutureyears,stanceisthenpredictedtorevert.
Beyondoneyearallestimatesareagainsmall.
Panel(b)displaystheresponseofgaptoitselfandtostance.Theown
responseofgaptogapshowsthetypicalmeanreversionpattern.Unusually,high
growthtodayingeneralpredictslowergrowthgoingforward.Theresponseofgap
tostanceshowstheconventionalresults:amonetarypolicycontractiontodayleads
toamorenegativeoutputgapinfutureyears,andtheeffectsarefeltevenouttotwo
yearsahead.
Thekeyone-yearaheadcross-responsesofstancetogapandgaptostance
impliedbythelocalprojectionsaredisplayedinChart7.Withoutmakinganycausal
inference,atighterstancepredictsloweroutputnextperiod,andhigheroutput
predictstighterstancenextperiod.Thisisexactlywhatstandardmodelswith
standardpolicyruleswouldleadustoexpect,andourstate-spacemodelisshownto
beinternallyconsistentonthesedimensions.
Finally,wenotethattheaverageeffectswereportareattenuatedbythe
endogenousresponseofpolicytotheoutlook.Thus,thefactthattheseestimatesare
stillsignificantandoftheconventionalsignisthereforenotable.Insum,themodel
outputpassesthissensecheck.
33
Table1LPdynamicsofstanceandgap,4-countrypanel(a)Responseofstancetochangesingapandstance
𝑟"y( − 𝑟"y(∗ 𝑟"y{ − 𝑟"y{∗ 𝑟"y| − 𝑟"y|∗ 𝑟"y} − 𝑟"y}∗ Δ(𝑦" − 𝑦"∗) 0.44** 0.27** -0.15 -0.16
(0.11) (0.13) (0.14) (0.14)
Δ(𝑟" − 𝑟"∗) 0.55** 0.16** 0.12 0.01 (0.07) (0.08) (0.08) (0.08)
N.obs 244 240 236 232(b)Responseofgaptochangesingapandstance
𝑦"y( − 𝑦"y(∗ 𝑦"y{ − 𝑦"y{∗ 𝑦"y| − 𝑦"y|∗ 𝑦"y} − 𝑦"y}∗ Δ(𝑦" − 𝑦"∗) -0.02 -0.51** -0.20 0.01
(0.07) (0.04) (0.09) (0.04)
Δ(𝑟" − 𝑟"∗) -0.12* -0.11** 0.02 0.02 (0.04) (0.03) (0.05) (0.03)
N.obs 244 240 236 232Notes:Author’scalculations.Seetext.Standarderrorsinparentheses, ∗p<0.10, ∗∗p<0.05.Chart7Responseofstancetogapandgaptostance,4-countrypanel
Notes:Partialbinscatters.Author’scalculations.Seetext.
-1.5
-1-.5
0.5
1d.
stan
ce(t
+1)
-3 -2 -1 0 1 2d.gap(t)
(a) 1-year response of stance to gap
-1.5
-1-.5
0.5
1d.
gap(
t+1)
-2 -1 0 1 2 3d.stance(t)
(b) 1-year response of gap to stance
34
VI. Localr*versusWorldr*asdriversofdomesticandinternationalmacroeconomicadjustment
Theprevioussectiontracedoutthe“terrestrial”dynamicsofhowgap
respondstostanceandstancerespondstogap.Asfaraspredictingshort-run
macroeconomicandpolicyoutcomes,everythingaccordedwithintuition.Butthisis
onlypartofthestory,asweknowfromthedecompositionatequation(11).What
about“celestial”forces,andhowtheyinteractwithmacroeconomicoutcomes?In
thissectionweturntothestartermsandexaminehowshiftsinthesenon-policy
variablespredictmediumtermmacroeconomicadjustmenttofundamentals.
Thegapbetweenlocalandworldnaturalratesmaysitoutsidelocal
policymakers’control,butaccordingtostandardtheoryitshouldhaveavery
importantinfluenceonlocaleconomicoutcomesviatheinternationaladjustment
process.Sinceourmodel-impliedestimatesgiveusawaytomeasurethegap
betweenlocalandworldnaturalrates,weareinapositiontoaskwhether
empirically,overthelongrun,theevidencesupportsthisviewofhowthe
mechanismsofinternationaladjustmentactuallywork.
Naturally,thisrequiresatransitiontoanopeneconomyframework.Again,
weeschewformalmodels,butwegroundourthinkingusingtheideaspresentedin
Clarida(2019).Thatpaper,followingClarida,Galí,andGertler(2002),explores
policyinatwo-countryDSGEmodelwithglobalandcountry-specificr*shocks
whichareafunctionofproductivityonly,aswellascostpushshocks.Clarida(2019)
mapsfromthemodeltotheempiricaleffectsseenintheHolston,Laubach,and
Williams(2017)fourindividualcountryestimatesusingavectorerrorcorrection
model(VECM)ofthenaturalrate.Inthisidealizedmodel,globalandlocalr*shocks
mustbothpassthroughintothelocalpolicyrateunderoptimalpolicy.4
4Oneinterestingcorollaryofthemodelisthat,undersymmetry,globalshocksdonotpassthroughintoexchangerates.Thereasonisthattheequilibriumexchangerateisafunctionof(transitory)PPPgapsandoutputgapsplusatermreflectingexpectedfuturerealnaturalratedifferentials.
35
Anotablefeatureofthesetupisthat,ifthenaturalrateisobservedperfectly
inrealtime,thecentralbankcanreplicatetheflexiblepriceequilibriumbypassing
throughthenaturalrateshockfullyandimmediatelytothepolicyrate.Inmore
realisticsettings,andasweseeinthedata,thepass-throughislikelytobegradual,
perhapsjustifiedbythesignalextractionproblemifthenaturalrateisknownonly
withnoise.Inthosemorerealisticcircumstances,underagradualincorporationof
realrateshocksintothepolicyrate,severalpatternsshouldbeexpected.A
hypothesizedpositiveproductivityshocktothelocalr*willbeaccompaniedbya
boominoutputandinflationthatpersists,butthestrongeconomywilleventually
betemperedbyarisingrealpolicyrate.Ontheway,thelocalstance—thedifference
betweennaturalandobservedrealrates,willbeelevated,andconsequentlythe
localcurrencyshouldbeexpectedtoappreciate,anotheradjustmentchannel.We
mightask,givenourmodeloutputs:isthisactuallythecaseinthedata?
Wethinkitisofinteresttoaskwhatotherstatisticalsignaturesanaturalrate
shockmightleaveinthedata,andthecurrentaccountidentitystandsoutasa
naturalnexusofinternationaladjustment.IntheClarida(2019)model,thischannel
isshutdownbylogpreferences(cf.ColeandObstfeld1991),butingeneralwea
expectnontrivialresponsesofsaving,investment,andthecurrentaccount.Along
theselines,Obstfeld(2019)proposesthattheeconomywiththehigher(lower)
autarkynaturalrealratewouldrunacurrentaccountdeficit(surplus)intheopen
economyequilibriumuntilequilibrationoccurs.Inthecaseofaproductivity-led
shocktothehomenaturalrate,withgradualadjustmenttoequilibrium,wewould
expectthecurrentaccounttomovetowarddeficitandtherealexchangerateto
appreciateendogenously.Inmanycanonicalmodels,withoutcapital,thiswouldbe
achievedviaconsumptionadjustment,butwherecapitalispresent,aproductivity-
ledriseinthehomenaturalratemightbeexpectedtostimulatehigherinvestment
also.
36
Ouraimhereistoundertakeapreliminaryandonlyinformalempirical
assessmentofthesemechanismsbypresentingsomesuggestivecorrelationsbased
ontheoutputofourstate-spacemodel.Wenowknowthatlocalandglobalnatural
ratestracktogetherinthelongrun,butlocal-globaldifferentialsclearlydoopenup
quitefrequentlywhen,fromtimetotime,localandglobalshocksdiffer.We
thereforeconditiononlocal-worldnaturalratedifferentialsandseeiftheycan
forecastmacroeconomicoutcomeslookingforward.Asafirstpass,weagainutilize
alocalprojectionframework,butnowwithaneyetomediumtermadjustment
dynamics.Thus,theoutcomevariableistheaverageresponseover3years.The
treatmentvariableisthegapbetweenlocalandworldlevelsofthenaturalrate.
TheseexperimentsarereportedinChart8.
Firstly,Panel(a)showsthepredictedresponseoftheoutputgap,inflation
gap,stance,andthe(trade-weighted)exchangeratetothelocal-worldnaturalrate
differential.Fromequation(4),asjustnoted,unlessstanceadjustsinstantly,a
higherlocalnaturalratewillbeassociatedwithoutputexceedingpotentialgoing
forward,astrongorhoteconomy.Then,fromequation(7)thiswillfeedintohigher
inflation.Subsequently,aspolicyadjusts,stanceshouldtighten,andtheexchange
rateshouldstrengthen.Thefiguresshowthatinthedatathesignofallfour
responsesaccordwiththislogic.Judgedhere,thestate-spacemodelfareswellin
matchingkeymacrovariablesofinterest.
Secondly,Panel(b)showstheresponseofthevariousflowmeasurestothe
local-worldnaturalratedifferential.Fromtheoryweexpectthatahigherlocal
naturalrate,allelseequal,wouldpredicthighercurrentaccountdeficitsinfuture,
andthisisverystronglythecaseinthedata,withapositivecorrelationbetween
CA/GDPratiosandther*differential.Weseethatthisresponseispartlydrivenbya
declineinlocalsaving/GDPratios,andariseinlocalinvestment/GDPratios.
37
Chart8Localr*,Worldr*,anddomesticandinternationalmacroeconomicadjustment
(a)3-yearaverageresponseofoutputgap,inflation,stance,andexchangerate
Notes:Partialbinscatters.Author’scalculations.Seetext.
-.2-.1
0.1
.2O
utpu
t gap
, 3y
avg.
-4 -2 0 2 4Local r* minus World r*
-2-1
01
2In
flatio
n ga
p, 3
y av
g.
-4 -2 0 2 4Local r* minus World r*
-1-.5
0.5
1St
ance
, 3y
avg.
-4 -2 0 2 4Local r* minus World r*
-.03
-.02
-.01
0.0
1.0
2Tr
ade-
wei
ghte
d ex
chan
ge ra
te, 3
y av
g. %
ch.
-4 -2 0 2 4Local r* minus World r*
38
Chart8(continued)Localr*,Worldr*,anddomesticandinternationalmacroeconomicadjustment
(b)3-yearaverageresponseofcurrentaccount,saving,investment,andcredit
Notes:Partialbinscatters.Author’scalculations.Seetext.
-2-1
01
2C
urre
nt A
ccou
nt/G
DP,
3y
avg.
-4 -2 0 2 4Local r* minus World r*
-2-1
01
2Sa
ving
/GD
P, 3
y av
g.
-4 -2 0 2 4Local r* minus World r*
-.02
-.01
0.0
1.0
2In
vest
men
t/G
DP,
3y
avg.
-4 -2 0 2 4Local r* minus World r*
-.05
0.0
5.1
Rea
l Loa
ns, 3
y av
g. %
ch.
-4 -2 0 2 4Local r* minus World r*
39
Allresponsesareconsistentwithstandardeconomiclogic.Relatedly,the
finalchartshowsthatthehigherCAdeficit,lowersaving,andhigherinvestment
responsesaremediatedbyaperiodofstrongergrowthinrealcreditgrowthinthe
localeconomy.Ofcourse,thiscreditboomresponsebringstomindtheconcerns
notedbyObstfeld(2019)thattheseshocksmaywellhavefinancialstabilityaswell
asmonetarypolicyimplications.5Theseresponsesaccordwithaninvestment
channelthatrunsthroughcreditmarkets,andsoonthisdimensiontheoutputofthe
state-spacemodelalsoappearsreasonable.
VII.Conclusion:Implicationsformonetarypolicy
Whatlessonsshouldpolicymakersdrawfromouranalysis?Itisworth
reflectingonwhattheoreticaleconomicmodelstellusfirst.Ononeside,Corsetti,
Dedola,andLeduc(2010)arguethat,outsidethelaboratoryoffrictionless
economies,incompleteexchange-ratepass-throughandassetmarketimperfections
(tonamejusttwopotentialfrictions)generatedistortionsandspilloversthatjustify
greaterinternationalmonetarypolicycooperation.Butsuchcooperationrequires
optimaldomesticpolicytoincorporateinternationalelementsthatdistortthe
optimaldomesticresponseundermonetaryautarky.AsClarida(2019)argues
persuasively,suchshort-rundistortionscanbeperceivedbythepublicasrunning
countertodomesticinterestsandhenceunderminethecredibilityofdomestic
centralbanks,thecornerstoneonwhichmoderncentralbankingrests.And
credibilityisparticularlyvaluablenowthatlowneutralrealratesofinterestare
likelytolimittraditionalinterestratepolicyinfavorofnontraditionalmonetary
tools,includingforwardguidance,whoseeffectivenessrestssquarelyoncredibility.
5SeeSchularickandTaylor(2012)andJordà,Schularick,andTaylor(2013)forevidencewhichshows,usingthesamedataset,thatcreditboomsareassociatedwithcostlyfinancialinstability.
40
Theoryprovidesadiscipliningdevicetothinkthroughtheconsequencesof
alternativescenariosinanorganizedmanner.But,intheend,whetheronepointof
vieworanotherisclosertothemarkcomesdowntotheempiricalevidence.Inthis
paperwestepawayfromtryingtoarbitratehowmuchcentralbankcooperation
thereshouldbe.Rather,wethinkitismoreusefultofirstdocumenttherealityof
howmuchpolicydivergencethereisinthedatacurrently,andinthepast,andto
exploreitssourcesandpotentialconsequences.
Aswediscussedearlier,measuringdivergencebydirectlycomparing
interestratesacrosseconomiesisacoarseandatheoreticalapproach.Asthe
decompositioninexpression(11)showed,interestratescanfluctuateduetothe
monetarypolicystance(i.e.,deviationsfromtheneutralrateofinterest),and
deviationsofthedomesticneutralratefromtheglobalneutralrate.Thelatteristhe
internationalequilibriumrateanchoringallotherrates.Inaworldwithperfect
capitalmobilityandrisksharing,thiswouldbetheequilibriumrateofinterestthat
wouldprevaileverywhere.Thebottomlineisthat,intheshort-run,onlythestance
isunderthecontrolofthemonetaryauthority.
Estimatesbasedonourmodelsuggestthatthecurrentdivergenceinneutral
ratesofinterestiswellwithinthehistoricalnorm.Andthisistrueforits
componentsaswell:therateofpotentialgrowth,andthelatentdriversofthe
neutralrate(aholdingtankforavarietyofotherdriversoftheneutralrate,suchas
demography,fiscalpolicy,financialdevelopment,andsoon),somethingthathadnot
alwaysbeenthecaseinearlierperiods.Infact,theevidenceprovidedinChart4
indicatesthatoverthepost-WW2era,thegrowthandlatentcomponentsofthe
domesticneutralrateareingreatersynchronytodaythanatanytimeinthepast.
Diggingdeeperintoeachcomponentandthemonetarypolicystancein
particular,Chart6,panel(e)suggeststhatdivergenceinthepolicystancehas
graduallydeclinedoverthepastsixdecadesandisnowatitslowestpoint.Andthis
41
ishappeningatthesametimeasthebusinesscyclehasbecomeincreasingly
synchronized,asChart6,panel(d)shows.
Returningtothesecondmajorcomponentofinterestrates,thegapbetween
thedomesticandtheglobalneutralrealrateofinterest,Chart8providesaclear
reminderthatthisgaphasimportantconsequencesfortheinternationaladjustment
ofkeyvariables.Asthebasiccorrelationsinthatchartshow,themorethedomestic
neutralratedivergesfromtheglobal,thebiggertheimpactonexchangerates,the
currentaccount,andcreditflowsdowntheroad.AsObstfeld(2019)explains,
persistentcurrentaccountimbalancescanbethecanaryinthecoalminethatwarns
ofimpendingimbalancesincreditmarketsandthusanelevatedriskoffinancial
fragility.
Finally,twothoughtsonbroaderpolicyimplications.
First,theneutralrategapshowsupinimportantwaysthatarerelevantto
understandingcurrenteconomicconditions.AsChart8shows,variationinthe
neutralrategapshowsuponinflationandtheoutputgap.Thus,acentralbanker
grapplingwithpersistentlylowinflationmustconsiderthepossibilitythatthe
domesticneutralratehasdroppedandthatthemonetarystanceneedstobe
accordinglyadjusted,evenwhenthereisconsiderableuncertaintyaboutwherethe
neutralratereallylies.
Second,thelongrealratehastrackeddownfairlyconsistentlywiththeshort
realrateoverrecentdecades.Thelatentfactorslope*tellsthisstory.Ourestimateof
thislow-frequencytermpremiumcomponentisstillpositive,albeitsmallerinJapan
andGermany(<100bps)andlargerinU.S.andU.K.(150–200bps).Thishas
implicationsforunconventionalmonetarypolicy,sinceasmallertermpremium,all
elseequal,reducesthepolicyspaceforlargescaleassetpurchasesaimedatshifting
theyieldcurve.
42
VII.A)Caveat:canpolicyaffecttheneutralrate?
Standardtheorysaysmoneyisneutralinthelongrun.Acentralbankcannot
usemonetarypolicytogenerategrowth,onlymitigateshort-runfluctuations.Ithas
noinfluenceontheneutralrate.Thisisthepositionweadoptinthispaper.Since
theGlobalFinancialCrisis,however,thiscanonhasbeenchallengedfromavariety
ofcorners.RecoveryfromthefinancialcrisisandtheEuropeansovereigncrisishas
beendisappointing.Realoutputisnotreturningtopre-crisistrends,aconsiderable
lossofwelfarewithsocialandpoliticalramificationsalltooapparent.Summers
(2016)arguedthatwemaybeinaneraofsecularstagnation,withchronicexcessof
savingoverinvestmentthatcanbebestsortedbyboostingpublicinvestment.Tight
fiscalpolicywhentheneutralrateislowcanhavecontractionaryspillovers
(Krugman2013;Setser2019;FornaroandRomeiforthcoming).
Meanwhile,someresearchraisesthepossibilitythatmonetarypolicydoesin
facthaveimportantconsequencesforthepotentialrateofeconomicgrowth.
BernankeandMihov(1998)providedempiricalevidenceofthelong-lastingeffects
ofmonetaryshocks.AtleastsinceStadler(1990),businesscyclemodelswith
endogenoustechnologyjustifywhyproductivitygrowthcanbeamplifiedor
attenuateddependingonwhethertheeconomyisinaboomorabust:R&D
investmentiscloselylinkedwiththebusinesscycle.RecentworkbyJordà,Singh,
andTaylor(2019)findsevidencetosupportthisview.Suchmechanismspaired
withthecurrentmacroeconomicoutlookandlowornegativeneutralrealratesof
intertest,suggestthatmonetarypolicycouldindeedhavelongruneffectsonthe
neutralrateofinterest.Tightlocalorglobalpolicystancecouldleadtolong-run
persistentdownturnsintheneutralrealrate.6Insuchascenario,theinternally
consistentpicturewehavepaintedmightneedtoberedrawnconsiderably.
6NotethatwhatwedescriberunscountertothecausalityinBorio,Disyatat,andRungcharoenkitkul(2019),whoclaimthataloosestancefostersendogenouslylowerneutralrates.
43
VII.B)Finalthoughts
TheGlobalFinancialCrisisleftaheavyimprintintheeconomiclandscape.
Theseedsforgreaterpolicydivergenceplantedbythecrisissproutedonbothsides
oftheAtlanticandthePacificinthepastfewyears.Anxietiesaboutthenegative
spilloversandstressesthatnon-coordinatedpolicydivergencemightplaceuponthe
systemhavebecomeapparent.Talkofcurrencywarsandexchangerate
manipulationstartedtomakeheadlines.
Yetwithoutfirmerempiricalevidence,ofthekindwepresenthere,itis
difficulttoknowhowconcernedweshouldbe.Andourargumentthatlong-run
forcesmatter,thattheseforcesarebeyondpolicymakers’control,andalsocontaina
strongglobalcomponent,couldsupportamorebenignnarrative.
Westressthatadirectcomparisonofinterestratesacrosscountriesistoo
coarseameasureofmonetarypolicydivergenceorlackofmonetarypolicy
coordination.Weshowthatthemonetarypolicystanceonlymakessensein
referencetotheneutralrateprevailingintheeconomy.Inaddition,aneconomy’s
neutralratecannotdivergefromtheglobalneutralrategiventhelevelsofrealand
financialintegrationcharacterizingmoderneconomies.
Acentralbankhasadutytoprotecttheeconomicandfinancialwelfareofits
citizens.Inaglobalizedeconomywithlowratesofgrowth,lowneutralrealratesof
interest,andtightfinancialintegration,carryingoutthatdutywillinevitablyrequire
centralbankstoadoptaglobalperspective.
44
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