Estimating and Evaluating a Fed Policy Rule with ChatGPT*

In a collaborative effort with the AI model ChatGPT, I’ve embarked on an analytical exploration of the Federal Reserve’s monetary policy decisions over the years. Leveraging a model inspired by Greg Mankiw’s approach, we’ve incorporated key economic indicators, including the 10-year government bond yields, to provide a more nuanced understanding of the Fed’s policy rule.

Integrating Bond Yields into Our Model

The inclusion of 10-year government bond yields in our OLS regression model, alongside unemployment and core CPI inflation, offers deeper insights into how the Fed’s policy decisions have been influenced by long-term market expectations and economic conditions.

Critical Periods in Federal Reserve Policy

Our analysis focuses on several pivotal periods in the Fed’s history, evaluating its responses to major economic challenges:

1. Early 1980s – Inflation Battle: Under Chairman Paul Volcker, the Fed’s aggressive interest rate hikes were crucial in taming the high inflation of the 1970s. Our model suggests these measures were necessary, though they came with significant economic trade-offs.
2. Tech Bubble Burst Around 2000: In response to the dot-com bubble’s burst, the Fed’s rate adjustments aimed to stabilize the economy. Our analysis indicates these were generally effective, but they possibly laid the groundwork for future market imbalances.
3. 2008 Financial Crisis: The Fed’s response to the financial crisis, including dramatic rate cuts and quantitative easing, was a bold departure from previous policy norms. Our model reflects these actions as crucial in mitigating the crisis’s impact, though their long-term implications remain a subject of debate.
4. Pandemic Response: The COVID-19 pandemic saw the Fed implementing near-zero interest rates and extensive monetary support. According to our model, this response was aligned with the unprecedented nature of the crisis, but a full evaluation will require more time and data.

Graph 1: Federal Funds Rate and Major Economic Events (1980-2020)

Current Monetary Stance

With the recent economic disruptions, the Fed faces a challenging balancing act. Our model, which now includes bond yields, suggests a cautious approach as the economy recovers from the pandemic’s impacts.

Graph 2: Actual vs. Predicted Federal Funds Rate (Including Yields)

Concluding Reflections

This comprehensive analysis, enriched by the inclusion of bond yields, underscores the intricate dynamics of the Federal Reserve’s policy decisions. Understanding past trends and current factors provides valuable insights for anticipating future policy directions.

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* The entire content of this blog post, including the modeling, was crafted by ChatGPT under my direction and guidance. In this process, I utilized ChatGPT as both a research assistant and a ghostwriter. ChatGPT has significantly aided in generating new ideas, enhancing my productivity. However, it’s important to note that ChatGPT’s standalone output often lacks significant interest. The true value emerges from the interactive synergy between ChatGPT and the user – that’s where the magic happens. For the data analysis presented here, I uploaded information from the St. Louis Fed FRED database into ChatGPT. (A plugin for this would be highly beneficial!)…even this was written by ChatGPT.