John Taylor’s Contributions to Monetary Theory and PolicyFederal Reserve Bank of Dallas, October 12-13, 2007
Comments on “Globalization and Monetary Policy”Prakash Loungani
IMF
• Thanks for inputs from Doug Laxton, Michael Kumhof & Alasdair Scott at IMF and from John Taylor. They are not to be blamed for any mis-use on my part of these inputs.
• Views are my own and should not be attributed to the IMF.
Story line and conclusions
• Taylor: a multilateralist driven to isolationism by the evidence– Carlozzi and Taylor (1985); Taylor (EER 1985)
– Work on multi-country models
• Bullard & Singh paper– Interesting, but doesn’t change my view of the world … yet
– And particularly because “benchmark” DSGE models seem to offer reasonable view of the world
• Clarida paper– CGG made easy; nice exposition
– But does it deliver a practical open economy Taylor rule for policy use?
• Globalization and Monetary Policy: Empirical Evidence– Globalization’s impact on the Phillips Curve: “strong” evidence (hint: it’s based on
my own work)
– Globalization and the Monetary Transmission Mechanism: still quite mixed, but evidence is pushing in direction of stronger role for open economy factors
Carlozzi and Taylor (1985): studied coordination in 2-country model
Carlozzi and Taylor (1985): found small gains from coordination
Figure 1: Inflation and Output Growth Variablity
US
UK
JA
IT
GR
FR
CA
USUK
JAITGRFRCA
0
1
2
3
4
5
6
7
0 1 2 3 4 5 6 7
Standard Deviation of Year-on-Year Output Growth
Sta
nd
ard
De
via
tion
of
CP
I In
flatio
n
1999-2006
1966-83
Figure 2: Inflation and Long-Term Interest Rate Variablity
CA
FR
GR
IT
JA
UK
US
CA
FR GRITJA
UK US
0
1
2
3
4
5
6
7
0 1 2 3 4 5 6 7
Standard Deviation of Long-Term Interest Rate
Sta
nd
ard
De
via
tion
of
CP
I In
flatio
n
1999-2006
1966-83
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.50.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Figure 3. U.S. Inflation and Output Volatility: Data and Model-Based Results(Percent)
Sources: Haver Analytics; and IMF staff calculations.
Standard deviation of output
Stan
dard
dev
iatio
n of
infla
tion
EF2: 1984–2006
EF1: 1966–83
A: Actual 1966–83
B: Actual1984–2006
More open economies have flatter Phillips curves (1)
Source: Loungani, Razin and Yuen, Journal of Development Economics, 2001
Lucas's estimated Phillips curve tradeoffs (AER '73) and capital mobility
00.10.20.30.40.5
0.60.70.80.9
1
0 0.1 0.2 0.3 0.4 0.5 0.6
Index of restrictions on capital mobility
Ph
illip
s c
urv
e t
rad
eo
ff
More open economies have flatter Phillips curves (2)
Ball-Mankiw-Romer Estimates of Output-Inflation Tradeoff
0
0.1
0.2
0.3
0.4
I II III IV
Index of restrictions on capital mobility
0
0.2
0.4
0.6
0.8
I II III IV
Source: Loungani, Razin and Yuen, Journal of Development Economics, 2001
More open economies have flatter Phillips curves (3)
Sacrifice ratios and openness
R2 = 0.2598
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
0 0.5 1 1.5 2 2.5 3 3.5 4
sacrifice ratios
open
nes
s
Globalization and Monetary Transmission Mechanism (1): Mishkin 2007
• What explains the decline in the sensitivity of inflation to domestic output gaps (i.e. flatter Phillips curves)?
– Channels: domestic prices less responsive to domestic resource utlization because of access to cheaper imports or lower likelihood of hitting up against supply bottlenecks. Little evidence in favor of these channels (Ihrig et al 2007; Wynne and Kersting 2007)
– Anchoring of long-term expectations: households and firms less likely to push for wage and price increases in face of rise in resource utilization (Mishkin 2007)
Globalization and Monetary Transmission Mechanism (2): Mishkin 2007
• Are foreign output gaps more important in domestic inflation?– Borio and Filardo 2007 suggest foreign slack more important than
domestic slack in explaining domestic inflation. But this conclusion is challenged in other studies
• Is transmission of monetary policy through exchange rates becoming more potent?
– Shocks to domestic demand have smaller impact on output in more open economies because of offsetting movements in the trade balance (Guerrieri, Gust and Lopez-Salido 2007)
– Declining correlations between real GDP growth and real domestic demand growth (Ihrig et al 2007)
Conclusions
• “Closed economy Taylor rule” has served us well for well over a decade
• Competition for a winning “open economy Taylor rule” is still on – CGG and Clarida paper offer useful theoretical leads– Coordination and indeterminacy are challenging complications
• “globalization has helped spread a common culture that stresses the benefits of achieving price stability” (Mishkin 2007) – John Taylor’s work has been crucial in spreading that “common
culture”. Thank you, John!