U.S. monetary policy needed corrections averaging about 30% in 1990-2019 to match the best feasible response, authors of research published Nov. 9 by the Federal Reserve Bank of New York said.
That compared with average corrections exceeding 100% in three earlier periods, the authors found.
The central bank published their findings in Liberty Street Economics under the title “Has U.S. Monetary Policy Really Improved? A 150-Year Perspective.”
The authors found little evidence of better systematic responses to economic shocks before the gains that followed Federal Reserve Chairman Paul Volcker’s campaign to bring down inflation. Their latest period ends in 2019.
Regis Barnichon, a senior research advisor at the Federal Reserve Bank of San Francisco, and Geert Mesters, an economic research advisor at the New York Fed, developed the comparison.
Their approach measures policy against the best response feasible under the economic disruptions policymakers faced. The authors said this separates the quality of decisions from circumstances that can produce poor results even when officials respond well.
They examined four periods: the gold standard era of 1879-1912, the early Federal Reserve in 1913-1941, the postwar period of 1954-1984 and the post-Volcker period of 1990-2019.
The authors estimated how much policymakers should have changed their interest-rate responses, expressed as a percentage of the observed response. The roughly 30% figure represents the average absolute correction in the latest period.
They found those later corrections were statistically indistinguishable from zero. A second measure estimated how much damage to inflation and unemployment the best feasible response could have prevented.
By that measure, the authors found that early Federal Reserve mistakes cost much more than those during either the gold standard or postwar periods. Similar shortcomings in decisions could therefore have different economic consequences.
The largest improvement came in responses to financial shocks, the authors found. During the 1920s and 1930s, banking panics were followed by higher policy rates while inflation fell, increasing interest rates after adjusting for inflation.
Their estimates indicated that cutting rates instead would have helped stabilize inflation and unemployment. In 1990-2019, the Federal Reserve already cut rates after financial shocks, leaving much smaller estimated room for improvement.
The authors found a different failing in the postwar period, which included the high inflation of the 1960s and 1970s. Officials responded too weakly to energy prices, productivity changes and shifts in inflation expectations.
Their estimates called for a stronger interest-rate response when inflation expectations rose. The authors concluded that better responses to financial crises and supply shocks accounted for much of the later improvement.
The findings reflect the authors’ views and do not necessarily represent those of the New York Fed or the Federal Reserve System.
