This Commentary estimates the implied parameters of simple monetary policy rules using the median paths for the federal funds rate and other economic variables provided in the Federal Open Market Committee's Summary of Economic Projections (SEP). The implied policy rule parameters appear to have changed over time, as the federal funds rate projections have become less responsive to the unemployment gap. This finding could reflect changes in policymakers' preferences, uncertainty over other aspects of the policy rule, or limitations of estimating simple monetary policy rules from the median SEP paths.  Read More

The Institute for Supply Management produces a measure of pricing trends, the manufacturing price index or ISMPI, that is constructed from its periodic surveys of purchasing and supply executives. We investigate this measure’s predictive content for producer and consumer price inflation by assessing its ability to improve inflation forecasts for three broad monthly inflation measures. We find that the ISMPI has some predictive content for producer prices but not for consumer prices.  Read More

Using a flexible statistical model to project inflation outcomes into the future, this Commentary finds that the most likely path for inflation based on recent inflation dynamics is generally similar to what would have been expected given inflation dynamics in the late 1990s, but there is more uncertainty around the forecast now than in the late 1990s.  Read More

We use recently developed econometric tools to demonstrate that the Phillips curve unemployment rate–inflation rate relationship varies in an economically meaningful way across three phases of the business cycle. The first (“bust phase”) relationship is the one highlighted by Stock and Watson (2010): A sharp reduction in inflation occurs as the unemployment rate is rising rapidly. The second (“recovery phase”) relationship occurs as the unemployment rate subsequently begins to fall; during this phase, inflation is unrelated to any conventional unemployment gap. The final (“overheating phase”) relationship begins once the unemployment rate drops below its natural rate. We validate our findings in a forecasting exercise and find statistically significant episodic forecast improvement. Our analysis allows us to provide a unified explanation of many prominent findings in the literature.  Read More

The historical analysis of FOMC behavior using estimated simple policy rules requires the specification of either an estimated natural rate of unemployment or an output gap. But in the 1970s, neither output gap nor natural rate estimates appear to guide FOMC deliberations. This paper uses the data to identify the particular implicit unemployment rate gap (if any) that is consistent with FOMC behavior. While its ability appears to have improved over time, our results indicate that, both before the Volcker period and through the Bernanke period, the FOMC distinguished persistent movements in the unemployment rate from other movements; implicitly such movements were treated as an intermediate target, one that departs substantially from conventional estimates of the natural rate. We further investigate historical FOMC responses to inflation fluctuations. In this regard, FOMC behavior changed in the Volcker-Greenspan-Bernanke period: its response to the inflation rate became much stronger, and it focused more intensely on very persistent movements in this variable. Our results shed light on the “Great Inflation” experience of the 1970s, and are consistent with the view that political pressures effectively limited the FOMC response to the buildup of inflation. They also suggest new directions for DSGE modeling.  Read More

We study how the co-movement of inflation and economic activity affects real interest rates and the likelihood of debt crises. First, we show that for advanced economies, periods with procyclical inflation are associated with lower real interest rates. Procyclical inflation implies that nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. However, such procyclicality also increases sovereign default risk when the economy deteriorates, since the government needs to make larger (real) payments. In order to evaluate both effects, we develop a model of sovereign default on domestic nominal debt with exogenous inflation risk and domestic risk-averse lenders. Countercyclical inflation is a substitute with default, while procyclical inflation is a complement with it, by increasing default incentives. In good times, when default is unlikely, procyclical inflation yields lower real rates. In bad times, as default becomes more material, procyclical inflation can magnify default risk and trigger an increase in real rates.  Read More