## Friday, August 26, 2016

### Does Janet Yellen Have a New Magic Formula She is Relying on to Control the Economy?

Maybe.

She dumped some heavy stuff in Footnote 8 of the prepared remarks of her Jackson Hole speech that she delivered today.

Steve Goldstein reports has the details
Federal Reserve Chairwoman Janet Yellen has fought against a notion put forward by some in Congress to follow a mathematical formula to determine interest rates.

That said, in her keynote speech in Jackson Hole, there’s a footnote that lays out exactly such a rule. She says this rule is more “aggressive” than the so-called Taylor Rule, put forward by Stanford professor John Taylor that many Republicans in Congress have supported.

The more aggressive rule does a reasonably good job of accounting for movements in the federal funds rate in the decade prior to its falling to its effective lower bound in late 2008,” the footnote says. This formula is laid out in more detail in a little-noticed working paper published in August on the Federal Reserve’s website.

Now, to the formula: it involves four variables: so-called R-star, which is the longer-run normal value of the federal funds rate adjusted for inflation; the four-quarter moving average of core PCE inflation; the FOMC’s target for inflation; the unemployment rate and the longer-run normal rate of unemployment.
Here's the full footnote:
8. Consider the following policy rule: R(t) = R* + p(t) + 0.5[p(t)-p*]-2.0[U(t)-U*], where R is the federal funds rate, R* is the longer-run normal value of the federal funds rate adjusted for inflation, p is the four-quarter moving average of core PCE inflation, p* is the FOMC's target for inflation (2 percent), U is the unemployment rate, and U* is the longer-run normal rate of unemployment. Based on the medians of FOMC participants' latest longer-run projections, R* is approximately 1 percent and U* is about 4.8 percent. Accordingly, with the unemployment rate climbing to 10 percent and core PCE inflation falling to 1 percent in 2009, this rule would have prescribed lowering the federal funds rate to minus 9 percent at the depths of the recession. In contrast, the standard Taylor rule, which is half as responsive to movements in resource utilization, would have prescribed lowering the federal funds rate to minus 3-3/4 percent using the same estimates for R* and U*. The more aggressive rule does a reasonably good job of accounting for movements in the federal funds rate in the decade prior to its falling to its effective lower bound in late 2008, see David Reifschneider (2016), "Gauging the Ability of the FOMC to Respond to Future Recessions (PDF)," Finance and Economics Discussion Series 2016-068 (Washington: Board of Governors of the Federal Reserve System, August). For more information on the standard Taylor rule, see John B. Taylor (1993), "Discretion versus Policy Rules in Practice," Carnegie-Rochester Conference Series on Public Policy, vol. 39 (December), pp. 195-21

Of course, this is all madness. The idea that these variables will always dance in some type of coherent fashion is a big leap, fairy dust is certainly required.

According to Goldstein. it prescribed, for example, a federal funds rate of negative 9% at the depth of the recession.

Based on current data, the formula yields a federal funds rate recommendation  of 0.54%, which is above the current target between 0.25% and 0.5%.

-RW