John h. Cochrane john b. Taylor strateg I es

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John H. Cochrane and John B. Taylor

The chapters in this book were prepared and presented to help 

inform an important review of monetary policy undertaken by the 

Federal Reserve in 2019. Like the Fed’s review, the book focuses 

on the evaluation of strategies, tools, and communication practices 

for monetary policy. The chapters address two related questions 

that are central to an evaluation of policy. First, can a given strat-

egy be improved upon, for example, by altering the degree of data 

dependence, by reconsidering monetary tools or instruments, or by 

changing communications about the strategy? Second, how robust 

are different policy strategies? The aim of the conference and this 

book is to present the latest research developments and debate these 

crucial policy questions. It is meant to be an integral component of 

the monetary policy review, and of the academic and policy com-

munity’s ongoing evaluation of this review and its underlying stra-

tegic issues.

The results went well beyond our expectations. The formal pre-

sentations were original and insightful. The market symposium 

and policy symposium were exciting, with many novel points and 

suggestions. And the discussions—all recorded and transcribed 

here—by academic researchers, market participants, members of 

the media, and monetary policy makers covered much new ground. 

All of this, in our view, adds greatly to the review of policy that the 

Federal Reserve began. We are also confident that the results will 

be useful and relevant to a similar review by the European Central 

x Preface

Bank, which is now currently under way, and to broader under-

standing of how monetary policy should be conducted.

The leadoff chapter is by Richard Clarida, vice chair of the 

Federal Reserve Board. He considers the impact of models and 

markets on the strategy of monetary policy, emphasizing the 

key question of data dependence. “Data dependence” states that 

monetary policy should react to economic events as they come 

along rather than follow a preannounced track, but it should react 

in a predictable way. Data dependence needs to be clear about 

what data to respond to and what reaction depends on it, or it 

can appear to be whimsical and introduce uncertainty into the 


Clarida argues that there are two forms of data dependence. 

The first describes how the instruments of monetary policy should 

react to the numerical difference between actual economic out-

comes and target outcomes for inflation or unemployment. This 

is a normal rule-like question, and getting the right sign and size 

of response is essential. That the interest rate should react by more 

than one to one with the inflation rate is an example of rightsizing 

mentioned by Clarida.

The second type of data dependence considered by Clarida 

involves measurement of the key benchmarks in the policy rule: the 

equilibrium rate of interest and potential GDP, or the natural rate of 

unemployment. The rule in the first type of data dependence states 

that the deviation of the interest rate from the natural rate should 

react to the deviation of GDP from potential, or the deviation of the 

unemployment rate from the natural rate. One needs to measure 

those benchmarks as well as the actual unemployment and infla-

tion rates in order to properly set monetary policy. In recent years, 

empirical research has suggested that both the equilibrium inter-

est rate and the natural rate of unemployment should be adjusted 

down. That research has also shown, however, just how difficult it 

is to define and measure these quantities



Clarida emphasizes that both types of data dependence are part 

of rules-based monetary policy, not a reason to abandon strate-

gies for monetary policy. Clarida does not argue for altering the 

degree of data dependence, but rather for making it more accurate 

and embedding it into a rules-based framework. The more accurate 

and precise is the dependence of policy on data, better the policy 

strategy will be.

The second chapter is also about data dependence and policy 

strategy. Here Andrew Lilley and Ken Rogoff make the case, as their 

title has it, for implementing effective negative interest rate policy. 

When one plugs real-world inflation or output data into policy rules 

for the interest rate, one sometimes finds that the rules prescribe 

negative interest rates. Lilley and Rogoff argue that negative interest 

rates are no reason to hold the rate at zero or above.

They consider regulatory changes that would allow the interest 

rate to go more easily to -2 or -3 percent, including steps to stop peo-

ple from holding large amounts of cash, which pays a better rate, at 

0 percent, and potentially undermines negative interest rate policies. 

They recognize, however, that regulatory lags and other resistance 

might prevent this change, and thus consider alternatives to negative 

interest rates, such as quantitative easing (QE) to drive down longer-

term interest rates, helicopter money, forward guidance, and a higher 

inflation target. This part of the paper presents a valuable and bal-

anced summary of the pros and cons of such “unconventional” mon-

etary policies. The authors point out, however, that recent research 

indicates that quantitative easing may have had little or no effect in 

the United States, at least outside of the normal lender-of-last-resort 

role of the central bank and beyond its effect as a signal of how long 

the Fed is likely to keep interest rates at zero.

Lilley and Rogoff then go on to consider removing the zero or 

effective lower bound constraint, stating that the “elegant and effec-

tive tool to restore monetary policy effectiveness at the zero bound 

would be unconstrained negative interest rate policy, assuming 

xii Preface

all necessary legal, institutional, and regulatory changes were first 

instituted.” But they stress that “no country yet has taken the steps 

necessary to have the kind of deeply negative rates we are discuss-

ing here (say, minus 2 percent or more).” The discussion of possible 

regulatory changes in insightful and valuable, as is their discussion 

of layering and their response to critics of negative rates, including 

Monika Piazzesi later in this book. Anyone interested in the zero or 

effective lower bound on the interest rate—which is anyone inter-

ested in monetary policy—should read and consider this chapter 


In his commentary on Lilley and Rogoff, Andrew Levin agrees 

that “QE and other unconventional monetary policy tools are com-

plex, opaque, and ineffectual,” and he therefore proceeds to argue 

that reform is needed. He proposes a more extensive use of digital 

cash, drawing on his work with Michael Bordo, to allow negative 

interest rates to be used more widely.

Chapter 3 also deals with the lower bound on interest rates. 

Entitled “Tying Down the Anchor: Monetary Policy Rules and the 

Lower Bound on Interest Rates,” its authors, Thomas Mertens, of 

the San Francisco Fed, and John Williams, president of the New 

York Fed, use an econometric model to evaluate alternative policy 

rule and find the one that works best.

Mertens and Williams consider three types of monetary policy 

rules: (1) a standard inflation-targeting interest rate rule in which 

the Fed reduces its response to higher inflation and output, in order 

to bias the economy toward higher interest rates and inflation and 

thereby reduce the probability of hitting the lower bond; (2) a rule 

in which the average inflation target is higher than with standard 

inflation targeting, though the strength of responses to deviations 

is unchanged; and (3) price-level targeting rules, in which the Fed 

allows substantial inflation after a low-inflation episode, until the 

price level recovers to its target, and vice versa. A variant of rule 

(2) has a similar flavor. It is an interest rate rule that “makes up 



for past missed stimulus due to the lower bound” by allowing the 

central bank to condition its interest on the sum of past shortfalls 

in interest rate cuts, as identified in earlier work by Reifschneider 

and Williams.

They show, by simulating the policy rules in the model, that the 

price-level targeting rule and the Reifschneider-Williams make-

up-for-shortfalls rule work best among the alternatives. They 

conclude by noting that “further work is needed to evaluate their 

robustness by analyzing them within different economic models.” 

They also recommend quantitative assessment of the policy with 

an estimated larger-scale model.

In Chapter 4, Jim Hamilton offers “Perspectives on US Monetary 

Policy Tools and Instruments,” which points out that quantitative 

easing does not seem to have affected interest rates and the econ-

omy. This finding supports statements by Lilley and Rogoff and by 

Levin summarized above, and also comments by Peter Fisher in 

this book.

Hamilton presents empirical evidence in time-series charts that 

the longer-term interest rate rises during periods when the Federal 

Reserve is engaged in large-scale purchases of domestic bonds, 

rather than declining as the Fed expected. See especially Hamilton’s 

figure 4.2. This finding suggests that other Fed research—presented 

for example at the Chicago Fed review conference—should focus on 

explaining this reverse impact. The policy impact of quantitative eas-

ing on long-term interest rates is a key part of the Fed’s review, and 

a key part of its contingency plan for a future zero bound episode.

With Volker Wieland, we contribute chapter 5, which focuses on 

the robustness of current policy. The chapter compares the interest 

rate prescriptions that result from the rules published since 2017 

by the Fed in its semiannual Monetary Policy Report with the actual 

path of the federal funds rate. These rules include the Taylor rule, a 

“balanced-approach” rule, a difference rule that responds to growth 

rather than levels of inflation and unemployment, and two rules 

xiv Preface

that take particular account of periods with near-zero federal funds 

rates by implementing a forward-guidance promise to make up 

for zero bound periods with looser subsequent policy. The chapter 

evaluates these monetary policy rules in seven well-known mac-

roeconomic models—a small New Keynesian model, a small Old 

Keynesian model, a larger policy-oriented model, and four other 

models from the Macro Model Data Base. We regard robustness 

across models as an essential part of the evaluation process.

The chapter reports that departures—a measure of discretion—

from all the rules reported by the Fed were small in most of the 

1980s and 1990s, a period of relatively good macroeconomic per-

formance. However, such discretion began to grow again in the 

early 2000s, though not as large as in the 1970s, and this discretion 

amplified prior to the 2007–09 recession.

The chapter shows that the rules in the Fed’s Report work well. 

However, some are not very robust. The first difference rule does 

very well in forward-looking New Keynesian models but very 

poorly in backward-looking Old Keynesian models. The chapter 

also shows that many of the Fed’s reported rules are close to the 

inflation-output volatility curve of optimal rules. Any rule may be 

better than no rule.

In commenting in the chapter, David Papell notes that, in gen-

eral, deviations from rules are very large in poor performance peri-

ods and very low during periods with good performance. He also 

shows the importance of robustness by demonstrating how results 

from different models are much different from one another.

An important tradition of the monetary policy conferences held 

at the Hoover Institution in recent years has been the inclusion of 

market participants and policy makers into the debates and discus-

sions. In keeping this tradition, this book contains two fascinating 

symposia along these lines.

The first symposium is on the interaction of markets and policy. 

It brings market participants directly into the discussion, including 



Mickey Levy, Scott Minerd, and Laurie Hodrick, with an overview 

and introduction by George Shultz. The key issue addressed by all 

three presenters is that policy makers must take the interaction of 

markets and policy strategies into account when designing mon-

etary strategies. As Hodrick puts it: “The interaction of markets 

and policy is actually a full circle. Not only are firm valuations 

affected by Fed policy . . .  but the Fed also interprets data from the 

economy, including stock market price levels, as additional noisy 

signals with which to set its policy.” Levy and Minerd offer sug-

gestions for improvement that, in our view, would improve policy 

outcomes and should be seriously considered by the Fed. As Levy 

recommends, “The Fed must take the lead to break its negative 

self-reinforcing relationship with financial markets by taking steps 

to rein in its activist fine-tuning of the economy and focus on a 

strategy for achieving its dual mandate.” Minerd argues that the Fed 

should “allow more volatility in short-term rates through revised 

open market operations policy or setting a wider fed funds target 

range. This would allow short-term rates to more accurately reflect 

changes in the market demand for credit and reserves.”

The second symposium is on monetary strategies in practice. 

It brings Fed policy makers into the discussion, including Jim 

Bullard, Mary Daly, Robert Kaplan, and Loretta Mester, with 

Charles Plosser as the chair.

Bullard presents a new overlapping generations model and shows 

how a policy rule of nominal GDP targeting is optimal. Nominal 

GDP targeting is similar to price-level targeting, in that it follows a 

period of less inflation with a period of inflation above target, and 

expectations of that future inflation may help to stimulate the econ-

omy during any current recession. In this logic, it is a new rationale 

for an old approach to policy, but one that still gets much attention. 

Daly addresses the lower bound on interest rates, as do Mertens 

and Williams, and concludes, after carefully considering alterna-

tives, that “average inflation targeting [is] an attractive option.”

xvi Preface

Kaplan considers the main reasons that inflation has been below 

the Fed’s inflation target of two, and he draws the implication that 

“we don’t want inflation to run persistently below or above our 

2 percent target. Sustained deviations from our inflation target 

could increase the likelihood that inflation expectations begin to 

drift or become unanchored.”

Mester addresses the broadest aspects of the Fed’s review of its 

framework and concludes that “effective communication will be 

an essential component of the framework. I believe there are ways 

we can enhance our communications about our policy approach 

that would make any framework more effective.” She has several 

suggestions; the first, which seems particularly important, is that 

“simple monetary policy rules can play a more prominent role in 

our policy deliberations and communications. . . .  The Board of 

Governors has begun to include a discussion of rules as bench-

marks in the Monetary Policy Report. . . .  This suggests that sys-

tematic policy making is garnering more support.” In many ways, 

this recommendation and assessment, which concludes the policy 

panel and the whole conference, highlights the theme of this book 

Strategies of Monetary Policy.

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