Monetary Policy Inside and Out | An Interview with Larry Meyer

  • Wednesday, August 24, 2016
  • Tell us about your career, including your time at the Fed.

I became very interested in economics while studying at Yale. After earning my Bachelor of Economics there, I went on to graduate school at MIT. My first job was as a professor at Washington University in St. Louis. I loved teaching and taught there for 27 years.

Toward the end of my tenure there, I began Laurence H Meyer & Associates with two of my former graduate students and a $300 collective investment. Our goal was to do model-based forecasting and policy analysis, but we did not have a model and had never prepared a forecast or done policy analysis.

At the time, that market was dominated by three large firms who offered their clients opportunities to do forecasting using time-sharing methods. Our venture survived because we were at the technological edge of the industry–the first to put a commercially available macroeconometric model on the newly introduced personal computer. Clients could now do all their forecasting for a single annual fee–a fraction of what they had been paying for time sharing.

We had taken advantage of the PC revolution before competitors had even thought of doing so. It was creative destruction, and the other firms went out of business or shrunk dramatically. Our firm became the most respected macro model builder and forecaster and was called upon by government agencies to do policy analysis.

As this product was developing and my firm was growing, I was nominated by President Clinton to serve on the Federal Reserve Board of Governors. My time at the Fed was the highlight of my career. The job was exciting and rewarding, and I had a wonderful time brainstorming with the staff and presenting and defending my views on the outlook and monetary policy within the FOMC.

When my term at the Fed ended in 2002, my wife and I decided that we wanted to stay in Washington D.C., which we had come to love. I returned to the firm I had cofounded in 1982 (now called Macroeconomic Advisers), opened a D.C. office, introduced the Monetary Policy Insights service, and built a team to support it. We focused on the link between the U.S. economic outlook and monetary policy and worked with central banks, U.S. government agencies, hedge funds, asset managers, and global banks. We became one of the most respected voices on US monetary policy.

I had operated the Monetary Policy Insights service as if we were a virtually independent firm and decided to formalize that In early 2016. I took MPI and my D.C.-based team and began my own firm, LH Meyer, Inc., which I think of as the true successor to Laurence H. Meyer & Associates.

LH Meyer is a mixture of old and new directions. While I wanted to maintain Monetary Policy Insights as our core product, I also wanted to branch out. I have always had exceptional colleagues at MPI and, as I moved to LH Meyer, Dave Stockton joined me as Chief U.S. economist and partner in all the work here.

The first new direction was to prepare our own U.S. forecast.

Second, I wanted to expand the intellectual reach of our small team, and did so by assembling an extraordinary group of senior advisors who are an integral part of our work here.

The third and most dramatic new direction was our merger with the text analysis company Prattle to form Quiet Signal. Quiet Signal is a financial data and analysis company with Prattle operating as the data arm and LH Meyer as the research arm. This merger allowed me to once again move to the technological frontier by providing MPI clients access to Prattle’s cutting-edge central bank sentiment indexes. Prattle’s Fed sentiment indexes now complement and inform my judgment about the course of monetary policy.

  • How has monetary policy analysis evolved throughout your career?

There has been an extraordinary evolution in monetary policy analysis since my time in graduate school. In part, that reflects a change in macroeconomic models and, in part, a change in how we think about and modeling FOMC policy actions.

When I was leaving MIT, the primary debate on monetary policy was between monetarism, which emphasized the role of the money supply as the instrument of monetary policy, and the new Keynesian view, which emphasized rate setting as the monetary policy instrument and articulated and modeled the transmission mechanism from policy actions to the macro economy. As the new Keynesian framework was being further refined, it was challenged by work on rational expectations and a new paradigm embedded in Dynamic Stochastic General Equilibrium (DSGE) models that assumed the economy as always being in equilibrium. Those models are now used at many central banks, most often alongside structural macroeconometric models of the new Keynesian bent, like the Board staff’s FRB-US model.

Monetary policy analysis went through a transformation of its own as research focused on modeling the behavior of central banks using simple policy rules and optimal control methods. Monetary policymakers have had to adapt and be creative in their responses to the Great Recession and the slow recovery afterward, including using large purchases of longer term government securities, aggressive forward guidance, and, in some cases, negative rates.

The research agenda is now to assess how effective these tools were, how they can be made more effective, and to focus on how to adapt the monetary policy framework to what may be the new norm: a slow growth, low real interest rate environment. This means that monetary policymakers will be more frequently constrained by the effective lower bound for the funds rate, which, in turn means central banks may have to expand their toolkits and consider new strategies.

  • How can central banks best carry out their objectives?

Of course, the answer is to use their tools (rate setting or nonconventional policies) to achieve their mandate, which, in the case of the FOMC, is full employment and price stability. But there is a best practice standard for how to go about this.

First, central banks should be independent. When we talk about the independence of central banks, we’re not saying they should be able to chose the objectives of monetary policy. These should be–and are–set by legislatures. Central bank independence is about control, without political interference, of the day-to-day operations of monetary policy in pursuit of these objectives.

Second, explicit objectives are also essential. The legislative mandates can be vague, leaving many central banks to decide how to quantify these goals. Explicit objectives allow a central bank to communicate more clearly with the markets and enhance accountability.

Third, policy should be systematic and rule-like, although not bound mechanically to follow an explicit rule.

Fourth, central banks, through their actions and communications, need to anchor long-term inflation expectations at a level consistent with their explicit inflation objective.

Fifth, monetary policymakers today must also be creative and adaptable, able to expand the set of instruments and adopt new strategies.

Finally, good communication has now become a vital feature of best practices in central banking. This tool can make monetary policy more effective by aligning market expectations with policy intentions.

  • What does the future hold for monetary policy analysis?

From a central banking standpoint, it is essential for central banks to keep learning, integrating new insights about the macro economy and central banking best practices, and adapting to new realities.

For those who work to link developments in the outlook to future policy, the challenge is to continue to refine our models of the macro economy, adapting to circumstances we did not anticipate, identifying changes in the strategy of central banks, and building on our experience and judgment to interpret central bank communications and anticipate the future course of monetary policy.

Prattle is a great example of an innovation in central bank analysis, allowing us once again to move to the technological frontier by providing data-driven insights about trends in central bank sentiment to help market participants anticipate near-term policy actions and the market reaction. This technology-driven approach could be the next “big thing,” complementing, or, perish the thought, replacing the use of econometrics, judgment, and experiences in anticipating the near-term course of monetary policy.

Of course, by that time, technology will have allowed the FOMC to be replaced with an optimal and all-knowing rule, and I will be happily retired.

About Larry Meyer

Larry Meyer and Antulio Bomfim at the Macroeconomic Advisers Offices, Washington, DC, February 28, 2011.

Larry is the president of LH Meyer. While serving as a Board Governor under Alan Greenspan, Dr. Meyer became an influential FOMC member, building a reputation for independent thinking and straight talk about monetary policy. Before joining the Board, Larry was also a professor of economics and a former chairman of the economics department at Washington University, where he taught for 27 years. He is the author of A Term at the Fed: An Insider’s View.

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