Another call to abandond the Mankiw Rule

Story from Bloomberg:

Raghuram Rajan accurately warned central bankers in 2005 of a potential financial crisis if banks lost confidence in each other. Now the International Monetary Fund’s former chief economist says the Federal Reserve should consider raising rates, even as almost 10 percent of the U.S. workforce remains unemployed.


The problem with Taylor and Mankiw and Krugman monetary policy rules is that they are minimum variance norms, but the economy works constraints with maximum entropy. Production is positive definite (production networks seldom work in reverse). The economy manages positive definite with a precision adjustment. So we have this situation when the treasury curve, for example, is reasonably smooth and properly shaped for a deflated environment. Yet the rules we use all indicate that we should be disassembling autos and putting the parts back into inventory.

Because Ben does not get this, he is likely to be late to the party, yet again.

How much of the banking cycle is caused by this error in the Mankiw Rule?

(Chart courtesy of Andy Harless)
What is happening is that the sample rate in the economy subtly changes because of entropy maximization. But the Monetary Rules do not recognize this, hence we get a cycle comprised of the transaction rate difference in the economy and the implicit transaction rate assumed by the rule. The Taylor Rule will under sample, then over sample the economy. The rules do not detect the effect because they minimize variance, and the variance will be minimum, but it spreads and narrows as transaction rates make subtle changes.

The samples in the rule become aliased, is the technical term.

Check here and you can see that Krugman does not get the entropy effect. He talks about Zero Bound. But we are not zero bound. We are Zero Bound if we expect a years inventory to be consumed in a year. Here Kling talks about that. But, at the slower transaction rates, the consumer will consume the inventory in two years, the consumer inventory cycle has slowed down with lower transaction rates, so he keeps a large inventory over two years. The change in transaction rates comes from entropy maximization.

Hopefully these economists will figure it out, I know Brad Delong is on the case and Jim Hamilton gets it.