The Great Moderation （2）

The Taylor Curve and the Variability Tradeoff

Let us begin by asking what economic theory has to say about the relationship of output volatility and inflation volatility. To keep matters simple, I will make the strong (but only temporary!) assumption that monetary policymakers have an accurate understanding of the economy and that they choose policies to promote the best economic performance possible, given their economic objectives. I also assume for the moment that the structure of the economy and the distribution of economic shocks are stable and unchanging. Under these baseline assumptions, macroeconomists have obtained an interesting and important result. Specifically, standard economic models imply that, in the long run, monetary policymakers can reduce the volatility of inflation only by allowing greater volatility in output growth, and vice versa. In other words, if monetary policies are chosen optimally and the economic structure is held constant, there exists a long-run tradeoff between volatility in output and volatility in inflation.

The ultimate source of this long-run tradeoff is the existence of shocks to aggregate supply. Consider the canonical example of an aggregate supply shock, a sharp rise in oil prices caused by disruptions to foreign sources of supply. According to conventional analysis, an increase in the price of oil raises the overall price level (a temporary burst in inflation) while depressing output and employment. Monetary policymakers are therefore faced with a difficult choice. If they choose to tighten policy (raise the short-term interest rate) in order to offset the effects of the oil price shock on the general price level, they may well succeed--but only at the cost of making the decline in output more severe. Likewise, if monetary policymakers choose to ease in order to mitigate the effects of the oil price shock on output, their action will exacerbate the inflationary impact. Hence, in the standard framework, the periodic occurrence of shocks to aggregate supply (such as oil price shocks) forces policymakers to choose between stabilizing output and stabilizing inflation.⁶ Note that shocks to aggregate demand do not create the same tradeoff, as offsetting an aggregate demand shock stabilizes both output and inflation.

 

短期（原油）冲击下的政策选择命题：政策制订者需要在产出和通胀两者间作出选择。同样的命题摆在沃克尔面前：失业还是通胀？

 

This apparent tradeoff between output variability and inflation variability faced by policymakers gives rise to what has been dubbed the Taylor curve, reflecting early work by the Stanford economist and current Undersecretary of the Treasury John B. Taylor.⁷ (Taylor also originated the eponymous Taylor rule, to which I will refer later.) Graphically, the Taylor curve depicts the menu of possible combinations of output volatility and inflation volatility from which monetary policymakers can choose in the long run. Figure 1 shows two examples of Taylor curves, marked TC1 and TC2. In Figure 1, volatility in output is measured on the vertical axis and volatility in inflation is measured on the horizontal axis. As shown in the figure, Taylor curves slope downward, reflecting the theoretical conclusion that an optimizing policymaker can choose less of one type of volatility in the long run only by accepting more of the other.⁸ （两种类型的volatility之间有替代性）A direct implication of the Taylor curve framework is that a change in the preferences or objectives of the central bank alone--a decision to be tougher on inflation, for example--cannot explain the Great Moderation. Indeed, in this framework, a conscious attempt by policymakers to try to moderate the variability of inflation should lead to higher, not lower, variability of output.

                                           Figure 1 Monetary Policy and the Variability of Output and Inflation

                                                       

How, then, can the Great Moderation be explained? Figure 1 suggests two possibilities. First, suppose it were the case, contrary to what we assumed in deriving the Taylor curve, that monetary policies during the period of high macroeconomic volatility were not optimal, perhaps because policymakers did not have an accurate understanding of the structure of the economy or of the impact of their policy actions. If monetary policies during the late 1960s and the 1970s were sufficiently far from optimal, the result could be a combination of output volatility and inflation volatility lying well above the efficient frontier defined by the Taylor curve. Graphically, suppose that the true Taylor curve is the solid curve shown in Figure 1, labeled TC2. Then, in principle, sufficiently well executed policies could achieve a combination of output volatility and inflation volatility such as that represented by point B, which lies on that curve. However, less effective policies could lead to the economic outcome represented by point A in Figure 1, at which both output volatility and inflation volatility are higher than at point B. We can see now how improvements in monetary policy might account for the Great Moderation, even in the absence of any change in the structure of the economy or in the underlying shocks. Improvements in the policy framework, in policy implementation, or in the policymakers' understanding of the economy could allow the economy to move from the inefficient point A to the efficient point B, where the volatility of both inflation and output are more moderate.

 

政策不断改进引起曲线移动，进而导致Great Moderation状态的形成

 

Figure 1 can also be used to depict a second possible explanation for the Great Moderation, which is that, rather than monetary policy having improved, the underlying economic environment may have become more stable. Changes in the structure of the economy that increased its resilience to shocks or reductions in the variance of the shocks themselves would improve the volatility tradeoff faced by policymakers. In Figure 1, we can imagine now that the true Taylor curve in the 1970s is given by the dashed curve, TC1, and the actual economic outcome chosen by policymakers is point A, which lies on TC1. Improved economic stability in the 1980s and 1990s, whether arising from structural change or good luck, can be represented by a shift of the Taylor curve from TC1 to TC2, and the new economic outcome as determined by policy is point B. Relative to TC1, the Taylor curve TC2 represents economic outcomes with lower volatility in output for any given volatility of inflation, and vice versa. According to the "shifting Taylor curve" explanation, the Great Moderation resulted not from improved practice of monetary policy (which has always been as effective as possible, given the environment) but rather by favorable structural change or reduced variability of economic shocks. Of course, more complicated scenarios in which policy becomes more effective and the underlying economic environment becomes more stable are possible and indeed likely.

With this bit of theory as background, I will focus on two key points. First, without claiming that monetary policy during the 1950s or in the period since 1984 has been ideal by any means, I will try to support my view that the policies of the late 1960s and 1970s were particularly inefficient, for reasons that I think we now understand. Thus, as in the first scenario just discussed (represented in Figure 1 as a movement from point A to point B), improvements in the execution of monetary policy can plausibly account for a significant part of the Great Moderation. Second, more subtly, I will argue that some of the benefits of improved monetary policy may easily be confused with changes in the underlying environment (that is, improvements in policy may be incorrectly identified as shifts in the Taylor curve), increasing the risk that standard statistical methods of analyzing this question could understate the contribution of monetary policy to the Great Moderation.