Monday, February 15, 2010

History may repeat 

In this paper we provide some evidence on when central banks have shifted from expansionary to contractionary monetary policy after a recession has ended--the exit strategy. We examine the relationship between the timing of changes in several instruments of monetary policy and the timing of changes of selected real macro aggregates and price level (inflation) variables across U.S. business cycles from 1920-2007. We find, based on historical narratives, descriptive evidence and econometric analysis, that in the 1920s and the 1950s the Fed would generally tighten when the price level turned up. By contrast, since 1960 the Fed has generally tightened when unemployment peaked and this tightening often occurred after inflation began to rise. The Fed is often too late to prevent inflation.
Michael Bordo and John Landon-Lane, in a new NBER working paper (ungated copy here.) Since September 23rd's FOMC statement the Fed has been emphasizing "resource utilization" and "resource slack", code for unemployment. Will prices turn north again before the Fed starts this new policy?

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