John Williams, President and Chief Executive Officer, Federal Reserve Bank of San Francisco

John Williams

President and Chief Executive Officer

Monetary policy, Business cycles, Learning

John.C.Williams (at)




Working Papers
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What to Expect from the Lower Bound on Interest Rates: Evidence from Derivatives Prices

2018-03 | With Mertens | January 2018

abstract (+)
This paper analyzes the effects of the lower bound for interest rates on the distributions of expectations for future inflation and interest rates. We use a stylized model economy where the policy instrument is subject to a lower bound to motivate the empirical analysis. Two equilibria emerge: In the “target equilibrium,” policy is unconstrained most or all of the time, whereas in the “liquidity trap equilibrium,” policy is mostly or always constrained. We use options data on future interest rates and inflation to study whether the decrease in the natural rate of interest leads to forecast densities consistent with the theoretical model. We develop a lower bound indicator that captures the effects of the lower bound on the distribution of interest rates. Qualitatively, we find that evidence is largely consistent with the theoretical predictions in the target equilibrium and find no evidence in favor of the liquidity trap equilibrium. Quantitatively, while the lower bound has a sizable effect on the distribution of future interest rates, its impact on forecast densities for inflation is relatively modest.
Published Articles (Refereed Journals and Volumes)
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Measuring the Natural Rate of Interest: International Trends and Determinants

Journal of International Economics 108, May 2017, S59-S75 | With Holston and Laubach

abstract (+)
U.S. estimates of the natural rate of interest–the real short-term interest rate that would prevail absent transitory disturbances–have declined dramatically since the start of the global financial crisis. For example, estimates using the Laubach-Williams (2003) model indicate the natural rate in the United States fell to close to zero during the crisis and has remained there into 2016. Explanations for this decline include shifts in demographics, a slowdown in trend productivity growth, and global factors a ffecting real interest rates. This paper applies the Laubach-Williams methodology to the United States and three other advanced economies–Canada, the Euro Area, and the United Kingdom. We find that large declines in trend GDP growth and natural rates of interest have occurred over the past 25 years in all four economies. These country-by-country estimates are found to display a substantial amount of comovement over time, suggesting an important role for global factors in shaping trend growth and natural rates of interest.
supplement (+)
Holston_Laubach_Williams_estimates.xlsx – Estimates from Working Paper – Computer code for Working Paper
Holston_Laubach_Williams_real_time_estimates.xlsx – Real-time estimates
A Wedge in the Dual Mandate: Monetary Policy and Long-Term Unemployment

Journal of Macroeconomics 47A, March 2016, 5-18 | With Rudebusch

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In standard macroeconomic models, the two objectives in the Federal Reserve’s dual mandate—full employment and price stability—are closely intertwined. We motivate and estimate an alternative model in which long-term unemployment varies endogenously over the business cycle but does not affect price inflation. In this new model, an increase in long-term unemployment as a share of total unemployment creates short-term tradeoffs for optimal monetary policy and a wedge in the dual mandate. In particular, faced with high long-term unemployment following the Great Recession, optimal monetary policy would allow inflation to overshoot its target more than in standard models.
Measuring the Effect of the Zero Lower Bound on Medium- and Longer-Term Interest Rates

American Economic Review 104 (10), October 2014, 3154-3185 | With Swanson

abstract (+)
According to standard macroeconomic models, the zero lower bound greatly reduces the effectiveness of monetary policy and increases the efficacy of fiscal policy. However, private-sector decisions depend on the entire path of expected future short-term interest rates, not just the current short-term rate. Put differently, longer-term yields matter. We show how to measure the zero bound’s effects on yields of any maturity. Indeed, 1- and 2-year Treasury yields were surprisingly unconstrained throughout 2008 to 2010, suggesting that monetary and fiscal policy were about as effective as usual during this period. Only beginning in late 2011 did these yields become more constrained.
Measuring the Effect of the Zero Lower Bound on Yields and Exchange Rates in the U.K. and Germany

Journal of International Economics 92 (S1), 2014, 2-21 | With Swanson

abstract (+)
The zero lower bound on nominal interest rates began to constrain many central banks’ setting of short-term interest rates in late 2008 or early 2009. According to standard macroeconomic models, this should have greatly reduced the effectiveness of monetary policy and increased the efficacy of fiscal policy. However, these models also imply that asset prices and private-sector decisions depend on the entire path of expected future short-term interest rates, not just the current level of the monetary policy rate. Thus, interest rates with a year or more to maturity are arguably more relevant for asset prices and the economy, and it is unclear to what extent those yields have been affected by the zero lower bound. In this paper, we apply the methods of Swanson and Williams (2013) to medium- and longer-term yields and exchange rates in the U.K. and Germany. In particular, we compare the sensitivity of these rates to macroeconomic news during periods when short-term interest rates were very low to that during normal times. We find that: 1) USD/GBP and USD/EUR exchange rates have been essentially unaffected by the zero lower bound, 2) yields on German bunds were essentially unconstrained by the zero bound until late 2012, and 3) yields on U.K. gilts were substantially constrained by the zero lower bound in 2009 and 2012, but were surprisingly responsive to news in 2010–11. We compare these findings to the U.S. and discuss their broader implications.
A Defense of Moderation in Monetary Policy

Journal of Macroeconomics 38, 2013, 137-150

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This paper examines the implications of uncertainty about the effects of monetary policy for optimal monetary policy with an application to the current situation. Using a stylized macroeconomic model, I derive optimal policies under uncertainty for both conventional and unconventional monetary policies. According to an estimated version of this model, the U.S. economy is currently suffering from a large and persistent adverse demand shock. Optimal monetary policy absent uncertainty would quickly restore real GDP close to its potential level and allow the inflation rate to rise temporarily above the longer-run target. By contrast, the optimal policy under uncertainty is more muted in its response. As a result, output and inflation return to target levels only gradually. This analysis highlights three important insights for monetary policy under uncertainty. First, even in the presence of considerable uncertainty about the effects of monetary policy, the optimal policy nevertheless responds strongly to shocks: uncertainty does not imply inaction. Second, one cannot simply look at point forecasts and judge whether policy is optimal. Indeed, once one recognizes uncertainty, some moderation in monetary policy may well be optimal. Third, in the context of multiple policy instruments, the optimal strategy is to rely on the instrument associated with the least uncertainty and use alternative, more uncertain instruments only when the least uncertain instrument is employed to its fullest extent possible.
Monetary Policy Mistakes and the Evolution of Inflation Expectations

In The Great Inflation: The Rebirth of Modern Central Banking, ed. by Michael D. Bordo and Athanasios Orphanides | The University of Chicago Press, 2013. 255-297 | With Orphanides

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What monetary policy framework, if adopted by the Federal Reserve, would have avoided the Great Inflation of the 1960s and 1970s? We use counterfactual simulations of an estimated model of the U.S. economy to evaluate alternative monetary policy strategies. We show that policies constructed using modern optimal control techniques aimed at stabilizing inflation, economic activity, and interest rates would have succeeded in achieving a high degree of economic stability as well as price stability only if the Federal Reserve had possessed excellent information regarding the structure of the economy or if it had acted as if it placed relatively low weight on stabilizing the real economy. Neither condition held true. We document that policymakers at the time both had an overly optimistic view of the natural rate of unemployment and put a high priority on achieving full employment. We show that in the presence of realistic informational imperfections and with an emphasis on stabilizing economic activity, an optimal control approach would have failed to keep inflation expectations well anchored, resulting in high and highly volatile inflation during the 1970s. Finally, we show that a strategy of following a robust first-difference policy rule would have been highly effective at stabilizing inflation and unemployment in the presence of informational imperfections. This robust monetary policy rule yields simulated outcomes that are close to those seen during the period of the Great Moderation starting in the mid-1980s.
Have We Underestimated the Likelihood and Severity of Zero Lower Bound Events?

Journal of Money, Credit and Banking 44, 2012, 47-82 | With Chung, Laforte, and Reifschneider

abstract (+)
Before the recent recession, the consensus among researchers was that the zero lower bound (ZLB) probably would not pose a significant problem for monetary policy as long as a central bank aimed for an inflation rate of about 2 percent; some have even argued that an appreciably lower target inflation rate would pose no problems. This paper reexamines this consensus in the wake of the financial crisis, which has seen policy rates at their effective lower bound for more than two years in the United States and Japan and near zero in many other countries. We conduct our analysis using a set of structural and time series statistical models. We find that the decline in economic activity and interest rates in the United States has generally been well outside forecast confidence bands of many empirical macroeconomic models. In contrast, the decline in inflation has been less surprising. We identify a number of factors that help to account for the degree to which models were surprised by recent events. First, uncertainty about model parameters and latent variables, which were typically ignored in past research, significantly increases the probability of hitting the ZLB. Second, models that are based primarily on the Great Moderation period severely understate the incidence and severity of ZLB events. Third, the propagation mechanisms and shocks embedded in standard DSGE models appear to be insufficient to generate sustained periods of policy being stuck at the ZLB, such as we now observe. We conclude that past estimates of the incidence and effects of the ZLB were too low and suggest a need for a general reexamination of the empirical adequacy of standard models. In addition to this statistical analysis, we show that the ZLB probably had a first-order impact on macroeconomic outcomes in the United States. Finally, we analyze the use of asset purchases as an alternative monetary policy tool when short-term interest rates are constrained by the ZLB, and find that the Federal Reserve’s asset purchases have been effective at mitigating the economic costs of the ZLB. In particular, model simulations indicate that the past and projected expansion of the Federal Reserve’s securities holdings since late 2008 will lower the unemployment rate, relative to what it would have been absent the purchases, by 1-1/2 percentage points by 2012. In addition, we find that the asset purchases have probably prevented the U.S. economy from falling into deflation.
Simple and Robust Rules for Monetary Policy

In Handbook of Monetary Economics, 3B, ed. by Benjamin Friedman and Michael Woodford | North-Holland, 2011. 829-860

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This paper focuses on simple normative rules for monetary policy which central banks can use to guide their interest rate decisions. Such rules were first derived from research on empirical monetary models with rational expectations and sticky prices built in the 1970s and 1980s. During the past two decades substantial progress has been made in establishing that such rules are robust. They perform well with a variety of newer and more rigorous models and policy evaluation methods. Simple rules are also frequently more robust than fully optimal rules. Important progress has also been made in understanding how to adjust simple rules to deal with measurement error and expectations. Moreover, historical experience has shown that simple rules can work well in the real world in that macroeconomic performance has been better when central bank decisions were described by such rules. The recent financial crisis has not changed these conclusions, but it has stimulated important research on how policy rules should deal with asset bubbles and the zero bound on interest rates. Going forward the crisis has drawn attention to the importance of research on international monetary issues and on the implications of discretionary deviations from policy rules.
Welfare-Maximizing Monetary Policy under Parameter Uncertainty

Journal of Applied Econometrics 25, January 2010, 129-143 | With Edge and Laubach

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This paper examines welfare-maximizing monetary policy in an estimated micro-founded general equilibrium model of the U.S. economy where the policymaker faces uncertainty about model parameters. Uncertainty about parameters describing preferences and technology implies uncertainty about the model’s dynamics, utility-based welfare criterion, and the “natural” rates of output and interest that would prevail absent nominal rigidities. We estimate the degree of uncertainty regarding natural rates due to parameter uncertainty. We find that optimal Taylor rules under parameter uncertainty respond less to the output gap and more to price inflation than would be optimal absent parameter uncertainty. We also show that policy rules that focus solely on stabilizing wages and prices yield welfare outcomes very close to the first-best.
Imperfect Knowledge and the Pitfalls of Optimal Control Monetary Policy

In Central Banking, Analysis and Economic Policies: Monetary Policy Under Uncertainty and Learning, 13, ed. by Klaus Schmidt-Hebbel and Carl Walsh | Central Bank of Chile, 2009. 115-144 | With Orphanides

abstract (+)
This paper examines the robustness characteristics of optimal control policies derived under the assumption of rational expectations to alternative models of expectations formation and uncertainty about the natural rates of interest and unemployment. We assume that agents have imperfect knowledge about the precise structure of the economy and form expectations using a forecasting model that they continuously update based on incoming data. We also allow for central bank uncertainty regarding the natural rates of interest and unemployment. We find that the optimal control policy derived under the assumption of perfect knowledge about the structure of the economy can perform poorly when knowledge is imperfect. These problems are exacerbated by natural rate uncertainty, even when the central bank’s estimates of natural rates are efficient. We show that the optimal control approach can be made more robust to the presence of imperfect knowledge by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to the presence of imperfect knowledge about the economy provides an incentive to employ a “conservative” central banker. We then examine two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts. We find that these policies are robust to the alternative models of learning that we study and natural rate uncertainty and outperform the optimal control policy and generally perform as well as the robust optimal control policy that places less weight on stabilizing economic activity and interest rates.
Forecasting Recessions: The Puzzle of the Enduring Power of the Yield Curve

Journal of Business and Economic Statistics 27(4), 2009, 492-503 | With Rudebusch

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We show that professional forecasters have essentially no ability to predict future recessions a few quarters ahead. This is particularly puzzling because, for at least the past two decades, researchers have provided much evidence that the yield curve, specifically the spread between long- and short-term interest rates, does contain useful information at that forecast horizon for predicting aggregate economic activity and, especially, for signalling future recessions. We document this puzzle and suggest that forecasters have generally placed too little weight on yield curve information when projecting declines in the aggregate economy.
Heeding Daedalus: Optimal Inflation and the Zero Lower Bound

Brookings Papers on Economic Activity 2009(2), Fall 2009, 1-37

abstract (+)
This paper reexamines the implications of the zero lower bound on interest rates for monetary policy and the optimal choice of steady-state inflation in light of the experience of the recent global recession. There are two main findings. First, the zero lower bound did not materially contribute to the sharp declines in output in the United States and many other economies through the end of 2008, but it is a significant factor slowing recovery. Model simulations imply that an additional 4 percentage points of rate cuts would have kept the unemployment rate from rising as much as it has and would bring the unemployment and inflation rates more quickly to steady-state values, but the zero bound precludes these actions. This inability to lower interest rates comes at the cost of $1.8 trillion of foregone output over four years. Second, if recent events are a harbinger of a significantly more adverse macroeconomic climate than experienced over the preceding two decades, then a 2 percent steady-state inflation rate may provide an inadequate buffer to keep the zero bound from having noticeable deleterious effects on the macroeconomy assuming the central bank follows the standard Taylor Rule. In such an adverse environment, stronger systematic countercyclical fiscal policy and/or alternative monetary policy strategies can mitigate the harmful effects of the zero bound with a 2 percent inflation target. However, even with such policies, an inflation target of 1 percent or lower could entail significant costs in terms of macroeconomic volatility.
A Black Swan in the Money Market

American Economic Journal: Macroeconomics 1(1), January 2009, 58-83 | With Taylor

abstract (+)
The recent financial crisis saw a dramatic and persistent jump in interest rate spreads between overnight federal funds and longer-term interbank loans. The Fed took several actions to reduce these spreads, including the creation of the Term Auction Facility (TAF). The effectiveness of these policies depends on the cause of the increased spreads such as counterparty risk, liquidity, or other factors. Using a no-arbitrage pricing framework and various measures of risk, we find robust evidence that increased counterparty risk contributed to the rise in spreads but do not find robust evidence that the TAF had a significant effect on spreads.
Learning, Expectations Formation, and the Pitfalls of Optimal Control Monetary Policy

Journal of Monetary Economics 55, September 2008, S80-S96 | With Orphanides

abstract (+)
The optimal control approach to monetary policy has garnered increased attention in recent years. Optimal control policies, however, are designed for the specific features of a particular model and therefore may not be robust to model misspecification. One important source of potential misspecification is how agents form expectations. Specifically, whether they know the complete structure of the model as assumed in rational expectations or learn using a forecasting model that they update based on incoming data. Simulations of an estimated model of the U.S. economy show that the optimal control policy derived under the assumption of rational expectations can perform poorly when agents learn. The optimal control approach can be made more robust to learning by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to learning provides an incentive to employ a “conservative” central banker. In contrast to optimal control policies, two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts are shown to be robust to learning.
Revealing the Secrets of the Temple: The Value of Publishing Central Bank Interest Rate Projections

In Asset Prices and Monetary Policy, ed. by J.Y. Campbell | Chicago: University of Chicago Press, 2008. 247-284 | With Rudebusch | Posted with the permission of the University Chicago Press.

abstract (+)
The modern view of monetary policy stresses its role in shaping the entire yield curve of interest rates in order to achieve various macroeconomic objectives. A crucial element of this process involves guiding financial market expectations of future central bank actions. Recently, a few central banks have started to explicitly signal their future policy intentions to the public, and two of these banks have even begun publishing their internal interest rate projections. We examine the macroeconomic effects of direct revelation of a central bank’s expectations about the future path of the policy rate. We show that, in an economy where private agents have imperfect information about the determination of monetary policy, central bank communication of interest rate projections can help shape financial market expectations and may improve macroeconomic performance.
Learning and Shifts in Long-Run Productivity Growth

Journal of Monetary Economics 54(8), November 2007, 2421-2438 | With Edge and Laubach

abstract (+)
An extensive literature has analyzed the macroeconomic effects of shocks to the level of aggregate productivity; however, there has been little corresponding research on sustained shifts in the growth rate of productivity. In this paper, we examine the effects of shocks to productivity growth in a dynamic general equilibrium model where agents do not directly observe whether shocks are transitory or persistent. We show that an estimated Kalman filter model using real-time data describes economists’ long-run productivity growth forecasts in the United States extremely well and that filtering has profound implications for the macroeconomic effects of shifts in productivity growth.
supplement (+)
ELW_JME2007_updated_estimates.xlsx – Updated estimates of trend labor productivity growth
Robust Monetary Policy with Imperfect Knowledge

Journal of Monetary Economics 54, August 2007, 1406-1435 | With Orphanides

abstract (+)
We examine the performance and robustness properties of monetary policy rules in an estimated macroeconomic model in which the economy undergoes structural change and where private agents and the central bank possess imperfect knowledge about the true structure of the economy. Policymakers follow an interest rate rule aiming to maintain price stability and to minimize fluctuations of unemployment around its natural rate but are uncertain about the economy’s natural rates of interest and unemployment and how private agents form expectations. In particular, we consider two models of expectations formation: rational expectations and learning. We show that in this environment the ability to stabilize the real side of the economy is significantly reduced relative to an economy under rational expectations with perfect knowledge. Furthermore, policies that would be optimal under perfect knowledge can perform very poorly if knowledge is imperfect. Efficient policies that take account of private learning and misperceptions of natural rates call for greater policy inertia, a more aggressive response to inflation, and a smaller response to the perceived unemployment gap than would be optimal if everyone had perfect knowledge of the economy. We show that such policies are quite robust to potential misspecification of private sector learning and the magnitude of variation in natural rates.
Inflation Targeting under Imperfect Knowledge

In Monetary Policy under Inflation Targeting, 11, ed. by Frederic Mishkin, Klaus Schmidt-Hebbel | Santiago, Chile: Central Bank of Chile, 2007. 77-123 | With Orphanides

abstract (+)
A central tenet of inflation targeting is that establishing and maintaining well-anchored inflation expectations are essential. In this paper, we reexamine the role of key elements of the inflation targeting framework towards this end, in the context of an economy where economic agents have an imperfect understanding of the macroeconomic landscape within which the public forms expectations and policymakers must formulate and implement monetary policy. Using an estimated model of the U.S. economy, we show that monetary policy rules that would perform well under the assumption of rational expectations can perform very poorly when we introduce imperfect knowledge. We then examine the performance of an easily implemented policy rule that incorporates three key characteristics of inflation targeting: transparency, commitment to maintaining price stability, and close monitoring of inflation expectations, and find that all three play an important role in assuring its success. Our analysis suggests that simple difference rules in the spirit of Knut Wicksell excel at tethering inflation expectations to the central bank’s goal and in so doing achieve superior stabilization of inflation and economic activity in an environment of imperfect knowledge.
Monetary Policy under Uncertainty in Micro-Founded Macroeconomic Models

In NBER Macroeconomics Annual 2005, ed. by Gertler and Rogoff | Cambridge, MA: MIT Press, 2006. 229-287 | With Levin, Onatski, and N. Williams

abstract (+)
We use a micro-founded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data and then determine the policy under commitment that maximizes household welfare. We find that the performance of the optimal policy is closely matched by a simple operational rule that focuses solely on stabilizing nominal wage inflation. Furthermore, this simple wage stabilization rule is remarkably robust to uncertainty about the model parameters and to various assumptions regarding the nature and incidence of the innovations. However, the characteristics of optimal policy are very sensitive to the specification of the wage contracting mechanism, thereby highlighting the importance of additional research regarding the structure of labor markets and wage determination.
Monetary Policy with Imperfect Knowledge

Journal of the European Economic Association 4(2-3), April 2006 | With Orphanides

abstract (+)
We examine the performance and robustness of monetary policy rules when the central bank and the public have imperfect knowledge of the economy and continuously update their estimates of model parameters. We find that versions of the Taylor rule calibrated to perform well under rational expectations with perfect knowledge perform very poorly when agents are learning and the central bank faces uncertainty regarding natural rates. In contrast, difference rules, in which the change in the interest rate is determined by the inflation rate and the change in the unemployment rate, perform well when knowledge is both perfect and imperfect.
Monetary Policy in a Low Inflation Economy with Learning

In Monetary Policy in an Environment of Low Inflation; Proceedings of the Bank of Korea International Conference 2006 | Seoul: Bank of Korea, 2006. 199-228

abstract (+)
In theory, monetary policies that target the price level, as opposed to the inflation rate, should be highly effective at stabilizing the economy and avoiding deflation in the presence of the zero lower bound on nominal interest rates. With such a policy, if the short-term interest rate is constrained at zero and the inflation rate declines below its trend, the public expects that policy will eventually engineer a period of above-trend inflation that restores the price level to its target level. Expectations of future monetary accommodation stimulate output and inflation today, mitigating the effects of the zero bound. The effectiveness of such a policy strategy depends crucially on the alignment of the public’s and the central bank’s expectations of future policy actions. In this paper, we consider an environment where private agents have imperfect knowledge of the economy and therefore continuously reestimate the forecasting model that they use to form expectations. We find that imperfect knowledge on the part of the public, especially regarding monetary policy, can undermine the effectiveness of price-level-targeting strategies that would work well if the public had complete knowledge. For low inflation targets, the zero lower bound can cause a dramatic deterioration in macroeconomic performance with severe recessions occurring with alarming frequency. However, effective communication of the policy strategy that reduces the public’s confusion about the future course of monetary policy significantly reduces the stabilization costs associated with the zero bound. Finally, the combination of learning and the zero bound implies the need for a stronger policy response to movements in the price level than would otherwise be optimal and such a rule is effective at stabilizing both inflation and output in the presence of learning and the zero bound even with a low inflation target.
The Decline of Activist Monetary Policy: Natural Rate Misperceptions, Learning, and Expectations

Journal of Economic Dynamics and Control 29(11), November 2005, 1927-1950 | With Orphanides

abstract (+)
We develop an estimated model of the U.S. economy in which agents form expectations by continually updating their beliefs regarding the behavior of the economy and monetary policy. We explore the effects of policymakers’ misperceptions of the natural rate of unemployment during the late 1960s and 1970s on the formation of expectations and macroeconomic outcomes. We find that the combination of monetary policy directed at tight stabilization of unemployment near its perceived natural rate and large real-time errors in estimates of the natural rate uprooted heretofore quiescent inflation expectations and contributed to poor macroeconomic performance. Had monetary policy reacted less aggressively to perceived unemployment gaps, inflation expectations would have remained anchored and the stagflation of the 1970s would have been avoided. Indeed, we find that less activist policies would have been more effective at stabilizing both inflation and unemployment. We argue that policymakers, learning from the experience of the 1970s, eschewed activist policies in favor of policies that concentrated on the achievement of price stability, contributing to the subsequent improvements in macroeconomic performance of the U.S. economy.
Using a Long-Term Interest Rate as the Monetary Policy Instrument

Journal of Monetary Economics 52(5), July 2005, 855-879 | With Rudebusch and McGough

abstract (+)
Using a short-term interest rate as the monetary policy instrument can be problematic near its zero-bound constraint. An alternative strategy is to use a long-term interest rate as the policy instrument. We find when Taylor-type policy rules are used to set the long rate in a standard New Keynesian model, indeterminacy–that is, multiple rational expectations equilibria–may often result. However, a policy rule with a long rate policy instrument that responds in a “forward-looking” fashion to inflation expectations can avoid the problem of indeterminacy.
Inflation Scares and Forecast-Based Monetary Policy

Review of Economic Dynamics 8(2), April 2005, 498-527 | With Orphanides

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Central bankers frequently emphasize the critical importance of anchoring private inflation expectations for successful monetary policy and macroeconomic stabilization. In most monetary policy models, however, expectations are already anchored through the assumption of rational expectations and perfect knowledge of the economy. In this paper, we reexamine the role of inflation expectations by relaxing the assumption of rational expectations with perfect knowledge and positing, instead, that agents have imperfect knowledge of the precise structure of the economy and policymakers’ preferences, and rely on a perpetual learning technology to form expectations. We find that with learning, disturbances can give rise to endogenous inflation scares, that is, significant and persistent deviations of inflation expectations from those implied by rational expectations, even at long horizons. The presence of learning increases the sensitivity of inflation expectations and the term structure of interest rates to economic shocks, in line with the empirical evidence. We also explore the role of private inflation expectations for the conduct of efficient monetary policy. Under rational expectations, inflation expectations equal a linear combination of macroeconomic variables and as such provide no additional information to the policymaker. In contrast, under learning, private inflation expectations follow a time-varying process and provide useful information for the conduct of monetary policy.
Investment, Capacity, and Uncertainty: A Putty-Clay Approach

Review of Economic Dynamics 8(1), January 2005, 1-27 | With Gilchrist

abstract (+)
We embed the microeconomic decisions associated with investment under uncertainty, capacity utilization, and machine replacement in a general equilibrium model based on putty-clay technology. In the presence of irreversible factor proportions, a mean-preserving spread in the productivity of investment reduces investment at the project level, but raises aggregate investment, productivity, and output. Increases in uncertainty have important dynamic implications, causing sustained increases in investment and hours and a medium-term expansion in the growth rate of labor productivity.
Robust Estimation and Monetary Policy with Unobserved Structural Change

In Models and Monetary Policy: Research in the Tradition of Dale Henderson, Richard Porter, and Peter Tinsley, ed. by J. Faust, A. Orphanides, and D. Reifschneider | Washington, DC: Federal Reserve Board of Governors, 2005

abstract (+)
This paper considers the joint problem of model estimation and implementation of monetary policy in the face of uncertainty regarding the process of structural change in the economy. I model unobserved structural change through time variation in the natural rates of interest and unemployment. I show that certainty equivalent optimal policies perform poorly when there is model uncertainty about the natural rate processes. I then examine the properties of combined estimation methods and policy rules that are robust to this type of model uncertainty. I find that weighted averages of sample means perform well as estimators of natural rates. The optimal policy under uncertainty responds more aggressively to inflation and less so to the perceived unemployment gap than the certainty equivalent policy. This robust estimation/policy combination is highly effective at mitigating the effects of natural rate mismeasurement.
Imperfect Knowledge, Inflation Expectations, and Monetary Policy

In Inflation Targeting, ed. by Bernanke and Woodford | Chicago: University of Chicago Press, 2004. 201-234 | With Orphanides

abstract (+)
This paper investigates the role that imperfect knowledge about the structure of the economy plays in the formation of expectations, macroeconomic dynamics, and the efficient formulation of monetary policy. Economic agents rely on an adaptive learning technology to form expectations and to update continuously their beliefs regarding the dynamic structure of the economy based on incoming data. The process of perpetual learning introduces an additional layer of dynamic interaction between monetary policy and economic outcomes. We find that policies that would be efficient under rational expectations can perform poorly when knowledge is imperfect. In particular, policies that fail to maintain tight control over inflation are prone to episodes in which the public’s expectations of inflation become uncoupled from the policy objective and stagflation results, in a pattern similar to that experienced in the United States during the 1970s. Our results highlight the value of effective communication of a central bank’s inflation objective and of continued vigilance against inflation in anchoring inflation expectations and fostering macroeconomic stability.
Measuring the Natural Rate of Interest

Review of Economics and Statistics 85(4), 2003, 1063-1070 | With Laubach

abstract (+)
The natural rate of interest–the real interest rate consistent with output equaling its natural rate and stable inflation–plays a central role in macroeconomic theory and monetary policy. Estimation of the natural rate of interest, however, has received little attention. We apply the Kalman filter to estimate jointly time-varying natural rates of interest and output and trend growth. We find a close link between the natural rate of interest and the trend growth rate, as predicted by theory. Estimates of the natural rate of interest, however, are very imprecise and subject to considerable real-time measurement error.
supplement (+)
Laubach_Williams_updated_estimates.xlsx – Updated estimates of Laubach-Williams model
Laubach_Williams_real_time_estimates.xlsx – Real-time estimates of Laubach-Williams model – Replication code
Robust Monetary Policy with Competing Reference Models

Journal of Monetary Economics 50(5), July 2003, 945-975 | With Levin

abstract (+)
The existing literature on robust monetary policy rules has largely focused on the case in which the policymaker has a single reference model while the true economy lies within a specified neighborhood of the reference model. In this paper, we show that such rules may perform very poorly in the more general case in which non-nested models represent competing perspectives about controversial issues such as expectations formation and inflation persistence. Using Bayesian and minimax strategies, we then consider whether any simple rule can provide robust performance across such divergent representations of the economy. We find that a robust outcome is attainable only in cases where the objective function places substantial weight on stabilizing both output and inflation; in contrast, we are unable to find a robust policy rule when the sole policy objective is to stabilize inflation. We analyze these results using a new diagnostic approach, namely, by quantifying the fault tolerance of each model economy with respect to deviations from optimal policy.
The Performance of Forecast-Based Monetary Policy Rules under Model Uncertainty

American Economic Review 93(3), June 2003, 622-645 | With Levin and Wieland

abstract (+)
We investigate the performance of forecast-based monetary policy rules using five macroeconomic models that reflect a wide range of views on aggregate dynamics. We identify the key characteristics of rules that are robust to model uncertainty: such rules respond to the one-year-ahead inflation forecast and to the current output gap and incorporate a substantial degree of policy inertia. In contrast, rules with longer forecast horizons are less robust and are prone to generating indeterminacy. Finally, we identify a robust benchmark rule that performs very well in all five models over a wide range of policy preferences.
Robust Monetary Policy Rules with Unknown Natural Rates

Brookings Papers on Economic Activity 2002(2), December 2002, 63-145 | With Orphanides

abstract (+)
We examine the performance and robustness properties of alternative monetary policy rules in the presence of structural change that renders the natural rates of interest and unemployment uncertain. Using a forward-looking quarterly model of the U.S. economy, estimated over the 1969-2002 period, we show that the cost of underestimating the extent of misperceptions regarding the natural rates significantly exceeds the costs of overestimating such errors. Naive adoption of policy rules optimized under the false presumption that misperceptions regarding the natural rates are likely to be small proves particularly costly. Our results suggest that a simple and effective approach for dealing with ignorance about the degree of uncertainty in estimates of the natural rates is to adopt difference rules for monetary policy, in which the short-term nominal interest rate is raised or lowered from its existing level in response to inflation and changes in economic activity. These rules do not require knowledge of the natural rates of interest or unemployment for setting policy and are consequently immune to the likely misperceptions in these concepts. To illustrate the differences in outcomes that could be attributed to the alternative policies we also examine the role of misperceptions for the stagflationary experience of the 1970s and the disinflationary boom of the 1990s.
Three Lessons for Monetary Policy in a Low Inflation Era

Journal of Money, Credit, and Banking, November 2000, 936-966 | With Reifschneider

Putty-Clay and Investment: A Business Cycle Analysis

Journal of Political Economy, October 2000, 928-960 | With Gilchrist

Too Much of a Good Thing?

Journal of Economic Growth, March 2000, 65-85 | With Jones

Robustness of Simple Monetary Policy Rules under Model Uncertainty

In Monetary Policy Rules, ed. by Taylor | Chicago: University of Chicago Press, 1999 | With Levin and Wieland

Measuring the Social Return to R&D

Quarterly Journal of Economics, November 1998, 1119-1135 | With Jones

FRBSF Publications
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The Future Fortunes of R-star: Are They Really Rising

Economic Letter 2018-13 | May 21, 2018

Supporting Strong, Steady, and Sustainable Growth

Economic Letter 2018-10 | April 9, 2018

Expect the Expected: Staying Calm When the Data Meet the Forecasts

Economic Letter 2018-03 | February 5, 2018

Monetary Policy and the Economic Outlook: A Fine Balancing Act

Economic Letter 2017-36 | December 18, 2017

The Perennial Problem of Predicting Potential

Economic Letter 2017-32 | November 6, 2017

Interest Rates and the “New Normal”

Economic Letter 2017-29 | October 10, 2017

Monetary Policy’s Role in Fostering Sustainable Growth

Economic Letter 2017-22 | August 7, 2017

The Global Growth Slump: Causes and Consequences

Economic Letter 2017-19 | July 3, 2017

Preparing for the Next Storm: Reassessing Frameworks and Strategies in a Low R-star World

Economic Letter 2017-13 | May 8, 2017

Three Questions on R-star

Economic Letter 2017-05 | February 21, 2017

Looking Back, Looking Ahead

Economic Letter 2017-02 | January 23, 2017

Longview: The Economic Outlook

Economic Letter 2016-24 | August 22, 2016

Monetary Policy in a Low R-star World

Economic Letter 2016-23 | August 15, 2016

Economic Outlook: Springtime Is on My Mind

Economic Letter 2016-16 | May 16, 2016

Data Dependence Awakens

Economic Letter 2016-12 | April 11, 2016 | With Pyle

Rules of Engagement

Economic Letter 2016-06 | February 29, 2016

The Right Profile: Economic Drivers and the Outlook

Economic Letter 2016-05 | February 22, 2016

After the First Rate Hike

Economic Letter 2016-01 | January 11, 2016

Dancing Days Are Here Again: The Long Road Back to Maximum Employment

Economic Letter 2015-36 | December 7, 2015

The Economic Outlook: Live Long and Prosper

Economic Letter 2015-31 | October 5, 2015

Measuring Monetary Policy’s Effect on House Prices

Economic Letter 2015-28 | August 31, 2015

The Recovery’s Final Frontier?

Economic Letter 2015-23 | July 13, 2015

Macroprudential Policy in a Microprudential World

Economic Letter 2015-18 | June 1, 2015

Looking Forward: The Path for Monetary Policy

Economic Letter 2015-17 | May 26, 2015

Monetary Policy and the Independence Dilemma

Economic Letter 2015-15 | May 11, 2015

The Value of Lifelong Learning

Federal Reserve Bank of San Francisco 2014 Annual Report | Apr 2015

The View from Here: Outlook and Monetary Policy

Economic Letter 2015-08 | March 9, 2015

Navigating toward Normal: The Future for Policy

Economic Letter 2014-31 | October 20, 2014

Financial Stability and Monetary Policy: Happy Marriage or Untenable Union?

Economic Letter 2014-17 | June 9, 2014

The Economic Recovery and Monetary Policy: The Road Back to Ordinary

Economic Letter 2014-16 | June 2, 2014

The San Francisco Fed and the West: A Century of Reinvention

Federal Reserve Bank of San Francisco 2013 Annual Report | Apr 2014 | With Zuckerman

Housing, Banking, and the Recovery: The Outlook

Economic Letter 2014-02 | January 13, 2014

Rebalancing the Economy: A Tale of Two Countries

Economic Letter 2013-33 | November 12, 2013

Will Unconventional Policy Be the New Normal?

Economic Letter 2013-29 | October 7, 2013

Bubbles Tomorrow, Yesterday, but Never Today?

Economic Letter 2013-27 | September 23, 2013

The Economic Recovery: Past, Present, and Future

Economic Letter 2013-18 | July 1, 2013

Economic Outlook: Moving in the Right Direction

Economic Letter 2013-15 | May 20, 2013

Cash Is Dead! Long Live Cash!

Federal Reserve Bank of San Francisco 2012 Annual Report | Apr 2013

The Economy and Fed Policy: Follow the Demand

Economic Letter 2013-05 | February 25, 2013

Monetary Policy in Uncertain Times

Economic Letter 2013-02 | January 21, 2013

The Federal Reserve’s Unconventional Policies

Economic Letter 2012-34 | November 13, 2012

The Economic Outlook and Federal Reserve Policy

Economic Letter 2012-30 | October 1, 2012

The Outlook and Monetary Policy Challenges

Economic Letter 2012-22 | July 23, 2012

Monetary Policy, Money, and Inflation

Economic Letter 2012-21 | July 9, 2012

The Slow Recovery: It’s Not Just Housing

Economic Letter 2012-11 | April 9, 2012

Opening the Temple

Federal Reserve Bank of San Francisco 2011 Annual Report | Apr 2012

The Federal Reserve and the Economic Recovery

Economic Letter 2012-02 | January 17, 2012

Unconventional Monetary Policy: Lessons from the Past Three Years

Economic Letter 2011-31 | October 3, 2011

Economics Instruction and the Brave New World of Monetary Policy

Economic Letter 2011-17 | June 6, 2011

Maintaining Price Stability in a Global Economy

Economic Letter 2011-14 | May 9, 2011

What Is the New Normal Unemployment Rate?

Economic Letter 2011-05 | February 14, 2011 | With Weidner

Estimating the Macroeconomic Effects of the Fed’s Asset Purchases

Economic Letter 2011-03 | January 31, 2011 | With Chung, Laforte, and Reifschneider

The Shape of Things to Come

Economic Letter 2010-15 | May 17, 2010 | With Weidner

Monetary Policy in a Low Inflation Economy with Learning

Economic Review | 2010

How Big Is the Output Gap?

Economic Letter 2009-19 | June 12, 2009 | With Weidner

The Risk of Deflation

Economic Letter 2009-12 | March 27, 2009

Monetary Policy, Transparency, and Credibility: Conference Summary

Economic Letter 2007-12 | May 25, 2007 | With Dennis

Inflation Targeting under Imperfect Knowledge

Economic Review | 2007 | With Orphanides

Inflation Persistence in an Era of Well-Anchored Inflation Expectations

Economic Letter 2006-27 | October 13, 2006

Labor Markets and the Macroeconomy: Conference Summary

Economic Letter 2006-17 | July 21, 2006 | With Dennis

Robust Estimation and Monetary Policy with Unobserved Structural Change

Economic Review | 2006

Fiscal and Monetary Policy: Conference Summary

Economic Letter 2005-12 | June 10, 2005 | With Dennis

Technology, Productivity, and Public Policy

Economic Letter 2004-07 | March 12, 2004 | With Daly

The Natural Rate of Interest

Economic Letter 2003-32 | October 31, 2003

Simple Rules for Monetary Policy

Economic Review | 2003

Other Works
Show this section
Measuring the Natural Rate of Interest Redux

Business Economics 51(2), April 2016, 57-67 | With Laubach

abstract (+)
Persistently low real interest rates have prompted the question whether low interest rates are here to stay. This essay assesses the empirical evidence regarding the natural rate of interest in the United States using the Laubach-Williams model. Since the start of the Great Recession, the estimated natural rate of interest fell sharply and shows no sign of recovering. These results are robust to alternative model specifications. If the natural rate remains low, future episodes of hitting the zero lower bound are likely to be frequent and long-lasting. In addition, uncertainty about the natural rate argues for policy approaches that are more robust to mismeasurement of natural rates.
Will Interest Rates Be Permanently Lower?

VoxEU, ed. by Richard Baldwin | VoxEU, 2015

abstract (+)
Interest rates have been extremely low since the Global Crisis. This column surveys the recent debate over whether they will remain low, or return to normal. While an unequivocal answer is not possible, the evidence suggests a significant decline in average real rates – perhaps to as low as 1%.
The Decline in the Natural Rate of Interest

Business Economics 50 (2), April 2015, 57-60

abstract (+)
With the Federal Reserve widely expected to begin normalization of monetary policy in the wake of the Great Recession–perhaps in 2015–an important question for public policy and private-sector planning is what the “new normal” for interest rates is likely to be. In particular, are real interest rates likely to be lower in the future than in recent decades? An investigation through the use of the Kalman filter shows that the natural rate of interest–the real federal funds rate consistent with the economy operating at its full potential–has declined since 1980, especially after the Great Recession. This will have important implications for monetary policy and for the private sector, including recognition that the natural rate of interest is not fixed.
Policy Rules in Practice

Journal of Economic Dynamics and Control 49, December 2014, 151-153

abstract (+)
Over the past twenty years, monetary policy rules have played an increasingly central role in disucssions of monetary policy strategy and tactics at the Federal Reserve. This represented a sea change in thinking about monetary policy in terms of a systematic startagey rather than a sequence of policy decisions.
Monetary Policy at the Zero Lower Bound: Putting Theory into Practice

In Hutchins Center on Fiscal & Monetary Policy | Brookings Institution, 2014

Forward Policy Guidance at the Federal Reserve

VoxEU, 2013

abstract (+)
The Federal Open Market Committee has used various forms of forward guidance to influence the views of businesses, investors and households about where monetary policy is likely to be headed. This column by the President of the San Francisco Fed presents his views on the benefits, limitations and future role of forward policy guidance.
Two Cheers for Bagehot

In Challenges to Central Banking in the Context of Financial Crisis, ed. by Subir Gokarn | Academic Foundation, 2011. 333-347

Monetary Policy and Housing Booms

International Journal of Central Banking, 7(1), 2011, 345-354

abstract (+)
A multitude of factors contributed to the housing booms and crashes experienced in many countries and the ensuing global financial crisis. Much of the existing research on these issues assumes that agents have complete information about the economic environment and form rational expectations. This commentary argues that models with imperfect knowledge and learning provide a potentially rich avenue of research on issues related to housing bubbles and monetary policy. Such models open up an avenue for the endogenous emergence of bubble-like behavior and also provide channels by which monetary and supervisory policies can influence the development of bubbles.
Wrap-up Discussion

In Inflation in an Era of Relative Price Shocks, ed. by Fry, Jones, and Kent | Reserve Bank of Australia, 2010. 342-346

The Zero Lower Bound: Lessons from the Past Decade

In NBER International Seminar on Macroeconomics, 6, ed. by Reichlin and West | National Bureau of Economic Research, 2010. 367-375

Discussion of “Free Flows, Limited Diversification: Openness and the Fall and Rise of Stock Market Correlations, 1890-2001”

In NBER International Seminar on Macroeconomics, 6, ed. by Reichlin and West | University of Chicago Press, 2010. 48-52

The Phillips Curve in an Era of Well-Anchored Inflation Expectations

Manuscript, September 2006

Discussion of “Disagreement about Inflation Expectations”

In NBER Macroeconomics Annual 2003, ed. by Gertler and Rogoff | Cambridge, MA: MIT Press, 2004. 257-268

Discussion of “A Snapshot on Inflation Targeting in its Adolescence”

In The Future of Inflation Targeting, ed. by Kent and Guttmann | Reserve Bank of Australia, 2004. 43-46

Transition Dynamics in Vintage Capital Models: Explaining the Postwar Catch-Up of Germany and Japan

FRBSF Working Paper 2004-14, July 2004 | With Gilchrist

abstract (+)
We consider a neoclassical interpretation of Germany and Japan’s rapid postwar growth that relies on a catch-up mechanism through capital accumulation where technology is embodied in new capital goods. Using a putty-clay model of production and investment, we are able to capture many of the key empirical properties of Germany and Japan’s postwar transitions, including persistently high but declining rates of labor and total factor productivity growth, a U-shaped response of the capital-output ratio, rising rates of investment and employment, and moderate rates of return to capital.
The Responses of Wages and Prices to Technology Shocks

FRBSF Working Paper 2003-21, December 2003 | With Edge and Laubach

abstract (+)
This paper reexamines wage and price dynamics in response to permanent shocks to productivity. We estimate a micro-founded dynamic general equilibrium (DGE) model of the U.S. economy with sticky wages and sticky prices using impulse responses to technology and monetary policy shocks. We utilize a flexible specification for wage- and price-setting that allows for the sluggish adjustment of both the levels of these variables|as in standard contracting models|as well as intrinsic inertia in wage and price inflation. On the price front, we find that in our VAR inflation jumps in response to an identified permanent technology shock, implying that, on average, prices adjust quickly and that there is little evidence for any intrinsic inflation inertia like that commonly found in models used for monetary policy evaluation. On the wage front, we find evidence for significant inertia in wages and some intrinsic inertia in nominal wage inflation. Our results provide support for the standard sticky-price specification of the New Keynesian model; however, the evidence on the high degree of wage inertia presents a challenge for standard models of wage setting.
The Evolution of Macro Models at the Federal Reserve Board

Carnegie-Rochester Conference Series, November 1999 | With Brayton, Levin, and Tryon

What’s Happened to the Phillips Curve?

FEDS Working Paper 1999-49, September 1999 | With Brayton and Roberts

abstract (+)
The simultaneous occurrence in the second half of the 1990s of low and falling price inflation and low unemployment appears to be at odds with the properties of a standard Phillips curve. We find this result in a model in which inflation depends on the unemployment rate, past inflation, and conventional measures of price supply shocks. We show that, in such a model, long lags of past inflation are preferred to short lags, and that with long lags, the NAIRU is estimated precisely but is unstable in the 1990s. Two alternative modifications to the standard Phillips curve restore stability. One replaces the unemployment rate with capacity utilization. Although this change leads to more accurate inflation predictions in the recent period, the predictive ability of the utilization rate is not superior to that of the unemployment rate for the 1955 to 1998 sample as a whole. The second, and preferred, modification augments the standard Phillips curve to include an “error-correction” mechanism involving the markup of prices over trend unit labor costs. With the markup relatively high through much of the 1990s, this channel is estimated to have held down inflation over this period, and thus provides an explanation of the recent low inflation.
Aggregate Disturbances, Monetary Policy, and the Macroeconomy: The FRB/US Perspective

Federal Reserve Bulletin, January 1999, 1-19 | With Reifschneider and Tetlow

The Role of Expectations in the FRB/US Macroeconomic Model

Federal Reserve Bulletin, April 1997, 227-245 | With Brayton, Mauskopf, Reifschneider, and Tinsley