Countries around the world have fallen into one of the deepest recessions since the Great Depression -- a recession exacerbated by a severe financial crisis. Policymakers have responded vigorously to the current crisis to prevent deflation. Some analysts warn that the US policy response might be too proactive and cause a subsequent surge in inflation. At the same time, other analysts advise that the policy response in many other countries might not be active enough to fend off deflation. The author shows how Taylor rules can be used to evaluate monetary policy. He then compares actual policy during past deflation scares -- in Japan in the 1990s and in the US in the 2000s -- with how policy would have been conducted using Taylor rules based, to the extent possible, on data available at the time. The rule-based evidence suggests that Japan's monetary policy response during its scare might have been too weak, while the US response might have been too strong.
Was Monetary Policy Optimal During Past Deflation Scares? Roberto M Billi Economic Review - Federal Reserve
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