John Taylor’s Contributions to Monetary Theory and PolicyFederal Reserve Bank of Dallas, October 12-13, 2007

Comments on “Globalization and Monetary Policy”Prakash Loungani

IMF

• Thanks for inputs from Doug Laxton, Michael Kumhof & Alasdair Scott at IMF and from John Taylor. They are not to be blamed for any mis-use on my part of these inputs.

• Views are my own and should not be attributed to the IMF.

Story line and conclusions

• Taylor: a multilateralist driven to isolationism by the evidence– Carlozzi and Taylor (1985); Taylor (EER 1985)

– Work on multi-country models

• Bullard & Singh paper– Interesting, but doesn’t change my view of the world … yet

– And particularly because “benchmark” DSGE models seem to offer reasonable view of the world

• Clarida paper– CGG made easy; nice exposition

– But does it deliver a practical open economy Taylor rule for policy use?

• Globalization and Monetary Policy: Empirical Evidence– Globalization’s impact on the Phillips Curve: “strong” evidence (hint: it’s based on

my own work)

– Globalization and the Monetary Transmission Mechanism: still quite mixed, but evidence is pushing in direction of stronger role for open economy factors

Carlozzi and Taylor (1985): studied coordination in 2-country model

Carlozzi and Taylor (1985): found small gains from coordination

Figure 1: Inflation and Output Growth Variablity

US

UK

JA

IT

GR

FR

CA

USUK

JAITGRFRCA

0

1

2

3

4

5

6

7

0 1 2 3 4 5 6 7

Standard Deviation of Year-on-Year Output Growth

Sta

nd

ard

De

via

tion

of

CP

I In

flatio

n

1999-2006

1966-83

Figure 2: Inflation and Long-Term Interest Rate Variablity

CA

FR

GR

IT

JA

UK

US

CA

FR GRITJA

UK US

0

1

2

3

4

5

6

7

0 1 2 3 4 5 6 7

Standard Deviation of Long-Term Interest Rate

Sta

nd

ard

De

via

tion

of

CP

I In

flatio

n

1999-2006

1966-83

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.50.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Figure 3. U.S. Inflation and Output Volatility: Data and Model-Based Results(Percent)

Sources: Haver Analytics; and IMF staff calculations.

Standard deviation of output

Stan

dard

dev

iatio

n of

infla

tion

EF2: 1984–2006

EF1: 1966–83

A: Actual 1966–83

B: Actual1984–2006

More open economies have flatter Phillips curves (1)

Source: Loungani, Razin and Yuen, Journal of Development Economics, 2001

Lucas's estimated Phillips curve tradeoffs (AER '73) and capital mobility

00.10.20.30.40.5

0.60.70.80.9

1

0 0.1 0.2 0.3 0.4 0.5 0.6

Index of restrictions on capital mobility

Ph

illip

s c

urv

e t

rad

eo

ff

More open economies have flatter Phillips curves (2)

Ball-Mankiw-Romer Estimates of Output-Inflation Tradeoff

0

0.1

0.2

0.3

0.4

I II III IV

Index of restrictions on capital mobility

0

0.2

0.4

0.6

0.8

I II III IV

Source: Loungani, Razin and Yuen, Journal of Development Economics, 2001

More open economies have flatter Phillips curves (3)

Sacrifice ratios and openness

R2 = 0.2598

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

0 0.5 1 1.5 2 2.5 3 3.5 4

sacrifice ratios

open

nes

s

Globalization and Monetary Transmission Mechanism (1): Mishkin 2007

• What explains the decline in the sensitivity of inflation to domestic output gaps (i.e. flatter Phillips curves)?

– Channels: domestic prices less responsive to domestic resource utlization because of access to cheaper imports or lower likelihood of hitting up against supply bottlenecks. Little evidence in favor of these channels (Ihrig et al 2007; Wynne and Kersting 2007)

– Anchoring of long-term expectations: households and firms less likely to push for wage and price increases in face of rise in resource utilization (Mishkin 2007)

Globalization and Monetary Transmission Mechanism (2): Mishkin 2007

• Are foreign output gaps more important in domestic inflation?– Borio and Filardo 2007 suggest foreign slack more important than

domestic slack in explaining domestic inflation. But this conclusion is challenged in other studies

• Is transmission of monetary policy through exchange rates becoming more potent?

– Shocks to domestic demand have smaller impact on output in more open economies because of offsetting movements in the trade balance (Guerrieri, Gust and Lopez-Salido 2007)

– Declining correlations between real GDP growth and real domestic demand growth (Ihrig et al 2007)

Conclusions

• “Closed economy Taylor rule” has served us well for well over a decade

• Competition for a winning “open economy Taylor rule” is still on – CGG and Clarida paper offer useful theoretical leads– Coordination and indeterminacy are challenging complications

• “globalization has helped spread a common culture that stresses the benefits of achieving price stability” (Mishkin 2007) – John Taylor’s work has been crucial in spreading that “common

culture”. Thank you, John!