Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy

Abstract

The recent financial crisis and ensuing recession appear to have put the productive capacity of the economy on a lower and shallower trajectory than the one that seemed to be in place prior to 2007. Using a version of an unobserved components model introduced by Fleischman and Roberts (2011), we estimate that potential GDP in late 2014 was about 7 percent below the trajectory it appeared to be on prior to 2007. We argue that a significant portion of the recent damage to the supply side of the economy plausibly was endogenous to the weakness in aggregate demand-contrary to the conventional view that policymakers must simply accommodate themselves to aggregate supply conditions. Endogeneity of supply with respect to demand provides a strong motivation for a vigorous policy response to a weakening in aggregate demand, and we present optimal-control simulations showing how monetary policy might respond to such endogeneity in the absence of other considerations. We then discuss how other considerations-such as increased risks of financial instability or inflation instability-could cause policymakers to exercise restraint in their response to cyclical weakness. JEL: E23, E37, E52, E65

Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense?

“…The moderate degree of price stickiness, in turn, makes in ‡ation ‡uctuations less costly relative to output ‡uctuations. Our basic …nding that the central bank should respond vigorously to resource utilization is consistent with the arguments in Reifschneider, Wascher and Wilcox (2013) In the SW model, the chosen weight for the output gap has important implications for in ‡ation volatility, as the model features a prominent in ‡ation-output gap trade-o¤ along the e¢ cient frontier as de…ned in the seminal work of Taylor (1979) and Clarida, Galí and Gertler (1999). At …rst glance, this in ‡ation-output gap trade-o¤ may appear to be contradictory to Justiniano, Primiceri and Tambalotti (2013), who argue that there is no important trade-o¤ between stabilizing in ‡ation and the output gap.…”

“…2 7 A similar description of the dual mandate is also present in Svensson (2011), where the weight placed on economic activity is substantially higher than in Woodford (2003). See also Reifschneider, Wascher and Wilcox (2013) and English, López-Salido and Tetlow (2013).…”

Labor Force Participation: Recent Developments and Future Prospects

“…A separate analysis by Hall (2014) comes to a similar conclusion, but traces much of the decline beyond that of aging to a combination of an increase in disability recipients and the expansion of the food stamp program, both of which discourage participation by implicitly taxing earnings. Finally, pure time-series methods, such as those employed by Van Zandweghe (2012), Barnes et al (2013), and Reifschneider et al (2013), attribute between one half and twothirds of the decline in participation since 2007 to trend movements, although of course such analyses say little about the underlying sources of a declining trend participation rate.…”

A Wedge in the Dual Mandate: Monetary Policy and Long-Term Unemployment

“…12 Using long-run inflation expectations to anchor inflation dynamics is common, and we follow Reifschneider, Wascher, and Wilcox (2013) in using a series based on long-run expected inflation in the Survey of Professional Forecasters and the Hoey survey since 1980 and, before that, on a long moving average of actual inflation. is the difference between the long-term unemployment rate and a non-accelerating inflation rate of long-term unemployment, denoted NAIRU-L. 13 Comparing the columns in Table 2, it's clear that the short-term unemployment gap is a much more important determinant of inflation than the long-term unemployment gap-consistent with the accumulating evidence noted above.…”