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December 12, 2006

Prescott And Sawicky Take Opposite Views Of Monetary Policy

Prescott has his Five Macroeconomic Myths. Sawicky offers The Five Boxes of Populist Economics.  I sample an old exchange with Max -- in not one, not two, but three parts (at least) -- and try to make sense of it all at the Cleveland Fed's website.  A small taste:

So is [GDP below its potential] today, and can monetary policy do anything about it? Sawicky says yes, Prescott says no. What say I? Two-handed economist that I am, I may not go all the way to Prescott’s view—but I lean in that direction.

You can read the whole thing here.

BELATED UPDATE: pgl at Angry Bear wants to be clear about this:

... a two-handed economist understands that productivity shocks exists AND knows that Keynes had a point in his 1936 General Theory.


December 12, 2006 in Federal Reserve and Monetary Policy | Permalink


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Isn't Prescott one of those market clearing real business cycle types? That is - in his view, aggregate demand has no short-term effects. Keynesians like Max (include me in this camp) might agree with Prescott on the long-term impact of monetary policy, but we still think Keynes got the short-term basically right.

Posted by: pgl | December 12, 2006 at 08:35 PM

Of course RBC models allow for "aggregate demand" effects. For example, a temporary shock to either the tax rate on capital or labor will change household incentives to work and/or save.

What the basic RBC model implies (without modifications) is that monetary policy can not do anything to smooth real output fluctuations -- fluctuations caused by supply shocks (such as the solow residual) or even demand shocks (such as temporary shocks to taxes, as mentioned).

Posted by: Morris Davis | December 12, 2006 at 09:00 PM

If Prescott did not steal a Nobel Prize would we be entertaining his ideas here?
If Prescott hadn't shamelessly sided with Busheconomics would I be so reluctant to give him 5 min of my precious time?

Posted by: calmo | December 13, 2006 at 12:01 PM


In the attached paper, you say: "Monetary policy can be both the cause and the cure of deviations of the red line from the light-blue line—the 'output gaps' that a wise and benevolent central bank would squash."

How are we going to assess whether we have a "wise and benevolent central bank" or just one that thinks it it wise. In particular how are we to know whether or not the FED has thoroughly vetted competing theories and methods.

Where is FED discussion of alternatives and why they make much less sense than annointed theories and practices. Can you point me (or us) to these? In particular I'm interested in those that have not yet been tried, not just a look at what is now thought wise and what predated it.

Posted by: Dave Iverson | December 13, 2006 at 06:14 PM

If monetary policy can not do anything about it Wall Street sure is wasting a lot of resources on Fed watching.

If private businesses are profit maximizers why would they do this if their experience did not lead them to expect positive returns from such expenditures?

Posted by: spencer | December 14, 2006 at 12:03 PM

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