Fulcrum Research Papers 1 October 2012

Professor Woodford and the Fed

Gavyn Davies, Martin Brookes, Ziad Daoud and Juan Antolin-Diaz















Correspondence: martin.brookes@fulcrumasset.com
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Summary
This paper discusses the recent contribution of Professor Michael Woodford of
Columbia University to the debate on the future of monetary policy in the US.
Woodford, a justly renowned academic economist, has come to prominence in the
murkeLs us u resuIL oI IIs recenL puper uL Juckson HoIe, und CIuIrmun Bernunke`s
favourable comments about his work. He has made radical recommendations about
the future conduct of Fed policy, and many economists have viewed LIe ed`s ucLIons
in September as a significant step in the direction which Woodford would like to see.
An even larger step, which Bernanke mentioned in his recent press conference,
would be to adopt a target for the level of nominal GDP (NGDP), as recommended by
Woodford.
Some economists think that a further move by the Fed towards a NGDP level target is
now likely. This paper is more sceptical, arguing that there are significant differences
beLween WoodIord`s LIeoreLIcuI und empIrIcuI reseurcI, und LIe current state of
LIInkIng InsIde LIe ed. n IucL, we urgue LIuL LIe ed`s ucLIons In SepLember moved
less clearly in a Woodford direction than is often assumed. And although we can
supporL LIe cenLruI moLIvuLIon beIInd WoodIord`s recommenduLIon oI a NGDP level
target (i.e. the need to find ways of increasing monetary accommodation at a time of
demand deficiency, with a zero lower bound on interest rates), we think that the
suggested formulation faces risks and problems which make it hard for the Fed to
adopt in practice. Woodford and others may be able to address some of these issues
in future work.
WoodIord`s Juckson HoIe puper covers all of the major areas of debate which
surround LIe ed`s deveIopIng moneLurv sLruLegv. The present paper attempts to
understand these key debates by viewing them through the lens of Michael
Woodford. He argues that the most effective way for the Fed to ease monetary policy
further from here is via a specific type of communications policy, rather than more
quantitative easing (QE). In fact, his analysis of QE concludes that it is unlikely to
have much effect on the economy, except through signalling the determination of the
Fed to keep policy easy in the future. This conclusion stems in part from his belief
that the public recognises that it ultimately owns the central bank`s balance sheet, so
LIuL IL wIII Iook LIrougI ed purcIuses oI usseLs, und reuIIse LIuL noLIIng
fundamental has changed when QE occurs. This so-cuIIed WuIIuce neuLruIILv seems
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Fulcrum Research Papers - October 2012 3

to us improbable in practice. Woodford also seems to believe in (fairly) perfect
substitutability between assets, which would mean that Fed purchases of assets
cannot easily change their relative prices. n conLrusL Lo WoodIord, LIe ed`s sLuLed
view is that QE can still change asset prices through portfolio balance effects.
On forward guidance, Woodford argues in favour of targets which pre-commit the
Fed to remaining accommodative for longer than would be implied by standard
Taylor rules, which have guided monetary policy in the past. By promising to keep
policy accommoduLIve Ior Ionger, WoodIord`s poIIcv wouId InvoIve a rise in inflation
expectations, which reduces real interest rates and increases aggregate demand
today.
The specific target which Woodford recommends for the current circumstances is a
NGDP level target, where the level is determined by an extrapolation of the linear
trend in NGDP from 1990-2008. This means that actual NGDP is currently 14%
below the implied target, with the gap growing each year. If the Fed were to commit
to this target, it would need to accept that inflation could run above 2% per annum
for some time ahead. The current Fed would in effect be committing a future Fed to
accept above-target inflation, even after the level of real output had returned to
potential.
This might administer a powerful shock to expectations, which is exactly what
WoodIord wunLs. However, LIere ure probIems Iere. TIe poIIcv Is LIme InconsIsLenL
because it would not be in the interests of a future Fed to maintain a commitment
given several years earlier by other members of the Federal Open Market Committee
(FOMC). There would be a powerful incentive for the future FOMC to renege on their
predecessors` commILmenL. TIe murkeL knows LIIs now, so IL mIgIL noL beIIeve LIe
commitment in the first place.
Alternatively, the introduction of the policy might increase inflation expectations
sharply, and raise inflation uncertainty. This could be costly to fix in the long run.
Apart from these issues, the composition of the current shortfall in NGDP from its
target is not what most people seem to believe, and this could also cause problems.
Of the 14% NGDP gap, none is attributable to a shortfall in the price level below the
2% trend line ImpIIed In LIe ed`s InIIuLIon LurgeL. The entire amount is due to a
shortfall in real GDP. Woodford makes no allowance for the possibility that real GDP
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has fallen below its trend line because of a decline in the rate of growth of potential
GDP. By shooting for the extrapolated 1990-2008 trend line in real GDP, such an
approach would increase the risks that the price level would move permanently
higher. Woodford might be willing to accept this, but the Fed would have much
greater reluctance.
So, has the Fed bought any of these arguments? It has now accepted that
communications policy is central and that its guidance on forward policy should be
condILIoned on economIc cIrcumsLunces, ruLIer LIun beIng dependenL on LIe ed`s
current forecasts. These are clearly steps towards Woodford`s LIInkIng. However, the
Fed seems to believe that QE is still effective, unlike Woodford. The Fed has not
accepted that price inflation should be allowed to run above its 2% target for a period
after such a policy would be appropriate under standard policy rules. Nor has it
shown any desire to increase inflation expectations deliberately in order to bring
down real interest rates; in fact, rather the reverse. A NGDP level target remains as a
last resort option for the Fed, but only if economic conditions worsen considerably
from here.
The intellectual differences between the Fed and Professor Woodford still seem
significant.

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Introduction
n AugusL eucI veur, LIe worId`s IeudIng cenLruI bunkers guLIer In Juckson HoIe,
Wyoming for a conference hosted by the Federal Reserve Bank of Kansas. One of the
IIgIIIgILs uL LIIs veur`s conIerence wus u puper bv MIcIueI WoodIord
1
, a professor of
economics at Columbia University. The paper considered the problems of running
moneLurv poIIcv uL LIe zero Iower bound (ZLB) when short-term interest rates
cannot be lowered any further.
WoodIord`s puper Ius uLLrucLed u IoL oI uLLenLIon und ederuI Reserve CIuIrmun
Bernanke was asked about it in his September press conference following the
announcement of a radical new set of policy measures by the Federal Open Market
Committee (FOMC). He descrIbed WoodIord In gIowIng Lerms, cuIIIng IIm u co-
uuLIor und IrIend, und LIIs Ius nuLuruIIv Increused LIe murkeL Iocus on LIe puper
and its author.
It is important for investors to understand WoodIord`s arguments and how they
might influence the Fed. The present paper provides a guide to, and critique of, what
the Washington Post descrIbed us perIups LIe veur`s most important academic
paper.
The starting point for any economist considering the ZLB is how central bankers can
operate policy when they cannot lower rates any further. Twenty years ago this was
not a problem any economist or policy maker considered; the historic challenge
instead had been how to squeeze out inflation. But the experiences of Japan as its
economy stagnated during the 1990s and the Bank of Japan reduced rates effectively
to zero alerted economists to the issue. A lot more thinking followed during the
subsequent decade and this has continued as many central banks have pursued
'unconvenLIonuI poIIcIes` sucI us quantitative easing (QE). WoodIord`s puper buIIds
on this tradition and addresses two key questions. Specifically, he considers whether
a central bank can most effectively use communications policy or asset purchases to
achieve its goals after the ZLB is reached.

1
Woodford, M. (2012) Methods Of Policy Accommodation At The Interest-Rate Lower
Bound, presented at Federal Reserve Bank of Kansas Economic Policy 2012 Jackson Hole
Symposium.

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The main issues we discuss in this paper are:
x WoodIord`s vIews on forward guidance at the lower bound
x WoodIord`s vIews on asset purchases
x WoodIord`s proposed NGDP target
x TIe ed`s uLLILude Lowurds LIe WoodIord proposuIs

Monetary policy communication at the zero lower bound
A number of studies by economists emphasise that the ZLB on overnight interest
rates does not represent the limit of what a credible central bank can achieve in
terms of policy accommodation. In particular, a central bank which enjoys a high
degree of credibility can manipulate expectations of future policy to influence real
interest rates and economic activity today.
Woodford has been an intellectual leader in developing this approach, and he still
believes that it is the most important method by which a central bank can influence
the economy at the ZLB. A key plank in this literature is a result from Eggertsson and
Woodford
2
which states that by promising to keep the policy rate at zero, even after
the economy has recovered, the central bank is in fact promising an economic boom
in the future. This boom will raise future inflation, in turn raising inflation
expectations today. This will reduce the current real interest rate, creating an
incentive to consume and invest now. Eggertsson and Woodford were building on the
work of Paul Krugman
3
who argued in the late 1990s that in order to boost its
stagnant economy, Japan needed to lower real interest rates by promising to create
future inflation.
WoodIord`s Juckson HoIe puper empIusIses LIuL LIe rIgIL Lvpe oI poIIcv wouId be
history dependent, as opposed to the forward looking policies conducted in
normal times by central banks. Under a forward looking policy, the central bank sets
interest rates today by taking into account only present and future levels of economic
variables such as inflation, the output gap and unemployment. In contrast, under a

2
Eggertsson, G.B. and M. Woodford. (2003), OpLImuI MoneLurv PoIIcv In u IquIdILv Trup,
NBER Working Papers 9968, National Bureau of Economic Research, Inc.
3
Krugman, P. (1998) It's Baaack: Japan's Slump and the ReLurn oI LIe IquIdILv Trup,
Brookings Papers on Economic Activity, Economic Studies Program, The Brookings
Institution, 29 (2): 137-206.
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history dependent policy, once the economy has recovered, and the ZLB constraint
has ceased to be binding, the central bank may keep interest rates low, and allow for
higher inflation, to compensate for below-target inflation in the past. This type of
policy is not accounted for in standard inflation targeting rules, such as the well-
known Taylor rule.
Krugmun eIoquenLIv descrIbes LIIs Lvpe oI poIIcv us credIbIv committing to be
IrresponsIbIe-by promising higher inflation in the future, the central bank can
escape the ZLB and provide the needed monetary easing today. (Actually, we are not
convInced LIuL mucI oI subsLunce Ius been udded Lo Krugmun`s orIgInuI 18 InsIgIL
in the literature which has been published since then.) Similarly, Walsh (2009)
points out
4
that:
Rcisinq in[lction expectations and committing to reducing the policy interest rate
in the future are not separate policy options. It is by committing to lower future
policu rctes thct the centrcl bcnl c[[ects [uture in[lction ct the zero louer bound.
Of course, any central bank policy committee which commits to a higher future
inflation rate will face serious problems of credibility: they or their successors will
not have any incentive to deliver the promised inflation once the economy has
recovered, since it is in no-one`s InLeresL Lo Iuve IIgI InIIuLIon once the economy has
escaped the ZLB. The fact that there will be no incentive to deliver in the future
makes this policy time inconsistent, and therefore potentially not credible and
IneIIecLIve Loduv. WoodIord`s Iuvoured solution, at least in his Jackson Hole paper, is
an announced policy of nominal GDP (NGDP) targeting where the Fed commits to
restoring the level of NGDP back to the path it was following before the financial
crisis hit. We will discuss NGDP targeting in depth below.
Woodford also criticises the ed`s recent use of forward guidance as a monetary
policy communication tool. The FOMC, for instance, in its 9 August 2011 press
release, stated:
The Committee currentlu cnticipctes thct economic conditions--including low rates
of resource utilization and a subdued outlook for inflation over the medium run--

4
Walsh, C.E. (2009) Using Monetary Policy Lo SLubIIIze EconomIc AcLIvILv, in Federal
Reserve Bank of Kansas City Financial Stability and Macroeconomic Policy 2009 Jackson
Hole Symposium, 2010: 245-296.
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are likely to warrant exceptionally low levels for the federal funds rate at least
through mid-zo:(.
As Woodford points out, this type of statement offers a conditional forecast of what
the Fed thinks will happen to the interest rate, given currently available data. It is by
no means a categorical promise to keep the interest rate low until mid-2013
independent of the levels of activity and inflation - quite the contrary, it is a very
explicit statement that these low levels are warranted by the expected weakness of
economic activity, and would be revised were activity or inflation to strengthen.
Woodford argues quite persuasively that an extension of this form of forward
guidance can have the counter-producLIve eIIecL oI sIgnuIIIng LIuL LIe cenLruI bunk`s
forecast of economic activity has weakened since the last meeting. This can lead
market participants to become more pessimistic themselves, weakening activity
further.
WoodIord poInLs ouL LIuL oLIer cenLruI bunks` use oI Iorwurd guIdunce, In purLIcuIur
the Bank of Canada, has come closer to his recommendation of issuing a firm
commILmenL, noL u IorecusL. PerIups InIIuenced bv WoodIord`s resuILs, LIe OMC In
its 13 September 2012 meeting decided to modify its forward guidance to indicate
LIuL moneLurv poIIcv wIII remuIn uccommoduLIve for a considerable time after the
economic recovery strengthens. TIe IInk beLween LIIs Iunguuge und WoodIord`s
proposal is discussed in more detail below.
Woodford on quantitative easing
Woodford has quite a dim view of the effectiveness of QE, in marked contrast to the
stated position of the Fed. He distinguishes analytically between two components
which are involved in any programme of large scale asset purchases:
1. Pure QE, wIIcI Ie deIInes us buvIng sIorL-term bills using newly-created
bank reserves and therefore involving an increase in the size of the central
bunk`s buIunce sIeeL, und
2. OperuLIon TwIsL, In wIIcI LIe suIe of short-term bonds finances the
purchase of long-Lerm bonds wILI no cIunge In LIe sIze oI LIe cenLruI bunk`s
balance sheet.
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A policy of creating reserves to finance the purchase of long-term bonds, which is
wIuL LIe ed und mosL oLIers descrIbe us QE, is in fact equivalent to two separate
actions (pure QE plus Operation Twist), so its effectiveness depends on the efficacy
of its components. In most analyses of QE, and in the actual operating practices of
the Fed, these two components are bundled together, but Woodford finds it
analytically helpful to separate them.
His analysis of pure QE involves recognising that bank reserves have a special role in
the payments system and they are valued for the transaction services they provide as
well as the interest they pay. For that reason, interest on reserves must be lower than
that on other riskless short-term assets such as treasury bills-the difference being
LIe IIquIdILv premIum. Conventional monetary policy can influence the liquidity
premium through its control of the supply of reserves. As the central bank injects
more reserves by buying bills, the transactions value earned on a marginal increase
in reserves relative to treasury bills falls, leading to a reduction in the liquidity
premium, and a drop in the short rate on bills.
When the supply of reserves increases sufficiently to reduce the liquidity premium to
zero, the short rate on bills hits its lower bound. Further increases in reserves, as QE
is pursued, provide no additional liquidity service and banks become perfectly
indifferent between holding reserves and treasury bills. Because pure QE amounts to
exchanging two essentially identical assets, Woodford contends that it is impotent at
the ZLB. Banks simply hold more reserves than they did before, and nothing else is
changed in asset markets or the economy.
TurnIng Lo LIe second unuIvLIcuI componenL oI QE, OperuLIon TwIsL, LIe ed`s vIew Is
that this policy works through a portfolio-balance effect. This implies that the Fed
believes that the assets used in these operations (short and long-term bonds) are not
perfect substitutes for each other in private sector portfolios, and that the relative
prices of the assets adjust to changes in the quantity available for the public to hold.
As the central bank buys more long-term bonds, the resulting reduction in the net
supply of these bonds to the private sector increases their price, and long-term bond
yields fall. Similarly, as the central bank sells short-term bonds or bills to finance its
Operation Twist, their yield rises. Therefore, the overall result of Operation Twist is
to reduce long bond yields, though possibly at the cost of raising shorter term yields.
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TIe sume eIIecLs uppIv, In LIe ed`s vIew, Lo purcIuses oI morLguge bonds, LreusurIes
or indeed other assets.
Note that these portfolio balance effects assume that short and long-term bonds are
not regarded as perfect substitutes for each other by investors, so LIe prIvuLe secLor`s
demand curve for these assets is not perfectly elastic; therefore, changes in the
relative supply of these assets can change their prices and yields. Imperfect
substitutability between assets may exist for many reasons, including market
segmenLuLIon und preIerred IubILuL eIIecLs (see beIow).
Woodford seems to believe that these portfolio balance effects might indeed be
positive in some circumstances, for example in the case of QE1, though he does not
seem to think that the effects are generally likely to be as large as the Fed has
claimed.
Furthermore, he advances the argument that the separation between the public and
the central bank is merely a mirage, because the public ultimately owns the central
bank. As the central bank pursues its bond purchases, the public therefore continues
to own the same overall quantity of these assets through its ownership of the central
bank. Operation Twist simply transfers assets from one account to another with both
accounts belonging to the same holder. Since nothing has fundamentally changed,
prIces sIouId remuIn unuIIecLed bv LIe cenLruI bunk`s InLervention. Therefore,
Operation Twist should not influence bond yields.
This property of the ineffectiveness of Operation Twist is called Wallace neutrality.
5

L Is compurubIe Lo RIcurdIun equIvuIence In IIscuI poIIcv, wIere un Increuse In LIe
budget deficit is claimed to have no effect on aggregate economic activity because the
private sector rationally anticipates that at some point in the future it will need to pay
extra taxes to finance the increase in public debt, and adjusts its current spending
accordingly.
Woodford uses these theoretical arguments to cast doubts on the effectiveness of QE.
He then moves on to consider the empirical evidence. He points out that QE in Japan
and the US resulted in little change in NGDP despite the huge expansion in the

5
This is named after Wallace, N. (1981) A Modigliani-Miller Theorem for Open-Market
Operations, American Economic Review, 71 (3): 267-274.
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monetary bases.
6
In his view, this offers prima facie evidence that QE has been
ineffective.
Figure 1. The monetary base in the US and Japan


Source: Federal Reserve Board and Bank of Japan.

Woodford also pours cold water on some empirical studies which claim to have
found that QE has succeeded in reducing bond yields. For example, he dismisses a
much-cited paper based on event-study analysis
7
which examines the behaviour of
bond yields at around the times when QE has been announced by the Fed. This study
concludes that asset purchase programmes in the US lowered 10-year Treasury yields
by 91 basis points cumulatively, a figure that has often been used by the Fed.
Woodford argues that two of the episodes used in this study, accounting for 73 of the
total 91 basis point decline, were associated with statements that also contained

6
It is important to note, however, that Woodford admits that a policy of balance sheet
expansion by creation of reserves would be effective in achieving inflation and boosting
activity if the expansion were perceived to be permanent. But the Federal Reserve has always
been clear that it will unwind the expansion once the ZLB ceases to be a constraint, just as
Japan did in the mid-2000s.
7
Gagnon, J., M. Raskin, J. RemucIe und B. Suck (zo11) TIe InuncIuI MurkeL EIIecLs oI LIe
ederuI Reserve`s urge-Scale Asset Purchases, International Journal of Central Banking
7(1): 3-43.
Currency
Bank
Reserves
0.0
0.5
1.0
1.5
2.0
2.5
3.0
1
9
9
0

1
9
9
2

1
9
9
4

1
9
9
6

1
9
9
8

2
0
0
0

2
0
0
2

2
0
0
4

2
0
0
6

2
0
0
8

2
0
1
0

2
0
1
2

Trillions of USD
a. United States
Currency
Bank
Reserves
20
40
60
80
100
120
140
1
9
9
0

1
9
9
2

1
9
9
4

1
9
9
6

1
9
9
8

2
0
0
0

2
0
0
2

2
0
0
4

2
0
0
6

2
0
0
8

2
0
1
0

2
0
1
2

Trillions of Yen
b. Japan
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 12

significant forward guidance about interest rates in addition to news about asset
purcIuses. To IIm, QE InIIuences usseL prIces und vIeIds muInIv LIrougI u sIgnuIIIng
cIunneI ubouL LIe IuLure puLI oI sIorL ruLes. n LIuL sense, Ie sees QE us sImpIv
another form of communications policy, rather than a weapon which works in its
own right.
WIuL ure we Lo muke oI WoodIord`s scepLIcIsm ubouL LIe eIIecLIveness oI QE?
While the proposition that pure QE is ineffective at the ZLB is widely accepted, the
belief in perfect asset substitutability and Wallace neutrality, and hence the
irrelevance of Operation Twist, is more controversial. Wallace neutrality requires
strong conditions that seldom exist outside idealised theoretical models used by
economists. It requires that the public must be fully rational, forward looking and
highly informed about the economic and institutional system, to the extent that they
fully understand the conLenLs oI LIe cenLruI bunk`s buIunce sIeeL, und LIuL LIev Luke
full account of their ultimate ownership of it. That seems very far fetched.
There are also many reasons why perfect substitutability probably
8
might not hold.
An example of this is the preferred habitat framework, in which investors have
preferences for holding specific maturities of bonds. For example, pension funds and
life insurance firms have preferences for long-dated bonds while asset managers and
bank treasury departments prefer short to medium-maturity bonds. This creates
segmentation in the bond markets where supply shocks to a particular segment can
influence prices. Using this framework, a number of empirical studies
9
find that,
contrary to perfect substitutability, the maturity structure of government bonds has
an effect on bond yields. In that case, bond purchases by the central bank could also
be effective.

8
Perfect substitutability means that the demand curve on bonds of any maturity is flat. This
can result from having risk-neutral investors maximising their expected return regardless of
maturity as in the expectation hypothesis. It can also result in models with risk-averse
investors through a Wallace-neutrality type of argument.
9
These studies include Greenwood, R. and D. Vayanos (2010) Bonds Supply and Excess
Bond Returns, Working Paper; Doh, T. (2010) The Efficacy of Large-Scale Asset Purchases
at the Zero Lower Bound, Federal Reserve Bank of Kansas City Economic Review, Q2: 5-34;
Hamilton, J. and C. Wu (2012) TIe EIIecLIveness oI AILernuLIve MoneLurv PoIIcv TooIs In u
Zero Lower Bound Environment, Journal of Money, Credit and Banking (forthcoming); Li,
C. and M. Wei (2012) Term SLrucLure ModeIIIng wILI SuppIv ucLors und Lhe Federal
Reserve`s urge ScuIe AsseL PurcIuse Progrums, Finance and Economics Discussion Series,
Board of Governors of the Federal Reserve System.
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 13

Woodford does not discuss these studies, nor does he mention the empirical work
which the Fed Chairman himself has quoted to establish the effectiveness of QE. For
example, in his Jackson Hole speech, Bernanke quotes model simulations conducted
on LIe ed`s RBJUS economIc modeI, wIIcI concIude LIuL LIe IIrsL Lwo rounds oI
asset purchases have boosted real GDP by 3%, and employment by two million jobs,
as of 2012. This evidence is similar to that provided by the Bank of England in
support of the effectiveness of QE in the UK.
10

Although we are inclined to believe that past episodes of QE may have been more
effective in reducing bond yields and raising asset prices than Woodford concludes,
this does not automatically imply that future rounds of asset purchases will be
equally effective. There may be an effective lower bound on government bond yields,
because private investors may be unwilling to hold the duration risk implied in long-
term debt if yields drop below a certain level. Keynes suggested this in the General
Theory
11
, cuIIIng IL u IIquIdILv Lrup, und In Jupun bond vIeIds Iuve noL been ubIe Lo
settle below 1% for very long, no matter what happened to short rates, asset
purchases or inflation. With 10-year Treasury yields already very low at 1.7%, there
might be little scope for long-term bond purchases to have a further large effect on
yields. However, unlike Woodford, we believe that purchases of other assets (e.g.
agency mortgage-backed securities) can influence bond spreads, and therefore
economic activity. This would still allow QE to be somewhat effective by changing
asset prices, rather than simply by reinforcing the Fed`s communIcuLIons poIIcv.

7LPHLQFRQVLVWHQF\LQ:RRGIRUGVDSSURDFK
WoodIord`s kev concIusIon Is LIuL IurLIer rounds oI ed-style QE are unlikely to be
very effective, but that a certain type of communications strategy can still have very
important effects on the economy, even at the ZLB. His approach builds on previous
thinking about monetary policy when short-term interest rates hit zero. In that sense
IL represenLs un evoIuLIon oI economIsLs` LIInkIng. On LIe oLIer Iund, his proposed
policy marks a dramatic shift in thinking about how central bankers should behave.

10
Jovce, M., M. Tong und R. Woods (zo11), TIe UnILed KIngdom`s QuunLILuLIve EusIng
Policy: Design, Operation and Impact, Bank of England Quarterly Bulletin, Q3: 200-212.
11
Keynes, J.M. (1936) The General Theory of Employment, Interest and Money.
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 14

This shift could make it difficult for the policy to be wholeheartedly adopted in the
practical world of central banking.
AL LIe IeurL oI WoodIord`s proposuI Is LIe pIedge Lo keep InLeresL ruLes Iower Ior
longer and, crucially, to commit not to raise them as the economy improves. The flip
side to this is that inflation is likely to be higher than under existing policies.
Committing future central bankers to sit on their hands and do nothing as inflation
rises is the mechanism by which real interest rates across the yield curve can be
reduced today and activity is boosted.
Toduv`s cenLruI bunkers place great store in the stability of inflation expectations.
They come from a generation scarred by the experience of high inflation and the
costs of squeezing this out oI LIe svsLem. WoodIord`s poIIcv requIres cenLruI bunkers
to shift their behaviour, at least temporarily, and promise to pay less attention to
inflation. Whether or not this is the right thing to do, it is difficult for central bankers
to contemplate such a change. As such, the policy may not find favour inside the
Federal Reserve and other central banks, except in dire circumstances for the real
economy.
This same logic can be used to explain why the policy might not in fact work. Suppose
the Fed adopted precisely the policy rule Woodford espouses. A future Fed would
then be committed to leaving interest rates unchanged even as inflation rose and
businesses, politicians and households called for tighter monetary policy. It is hard to
imagine the FOMC then explaining credibly that its decision to leave rates on hold
was down to commitments made in the distant past. There would be considerable
pressure to renege on that historic pledge.
This is the problem of time inconsistency mentioned earlier-what is credible to
promise now becomes incredible to implement in the future. Economists have known
for several decades that policies with such a property face severe difficulties.
Analysts, investors and policymakers do not believe a policy which they can see
unravelling in the future. As a result of this, the announcement of a policy that has
the property of time inconsistency does not work in the first place, because no-one
believes it will actually be carried out when the time comes, whatever is said today.
Woodford recognises that the time inconsistency problem might render the policy
ineffective, but spends relatively little time considering it. He claims that publicly
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 15

committing to the policy will be sufficient to overcome the time inconsistency. It is
unclear whether this is sufficient: why should a future FOMC adhere to decisions
taken today if it thinks they are no longer In LIe economv`s InLeresLs? RegurdIess oI
any public commitment, this possibility makes the policy potentially ineffective. Even
if it can work, future central bankers will then face the difficulty of re-establishing
their anti-inflation credentials.

Inflation expectations and uncertainty
At the other extreme, there is a danger that the policy starts to unleash higher
inflation expectations. Low and stable inflation expectations are frequently taken as a
sIgn oI LIe success oI moneLurv poIIcv und LIe sLock oI cenLruI bunks` credIbIIILv. I
markets believed that an announcement of a Woodford-type policy rule heralded a
new era in which rising prices were going to be both tolerated and even encouraged,
this might unhinge inflation expectations. Some rise in expectations would be
welcomed-indeed, this is needed for the policy to work-but there is no guarantee it
could be controlled. There must be a risk that a central bank announcing a policy rule
which encouraged higher inflation might lose credibility and see expectations jump
much higher.
A further problem might be that inflation uncertainty jumps as markets try to
understand the implications of the new policy. Increased inflation uncertainty is
itself damaging to the economy as it raises real interest rates on long-term debt. For
any central banker to commit to change policy and take the risk of losing control over
inflation expectations like this would be a big step.
So, kev rIsks Ior WoodIord`s upproucI ure LIuL (u) IL does noL work becuuse IL Iuces
the problem of time inconsistency or (b) it works too well and sees an uncontrollable
surge in inflation expectations and uncertainty. Of course, it is improbable that both
of these problems would emerge at the same time. However, either way, central
bunks` credIbIIILv wouId suIIer und might prove hard to rebuild.


G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 16

Problems with a nominal GDP target framework
There is one other serious poLenLIuI probIem wILI WoodIord`s upproucI, sLemmIng
from his choice of target variable. Woodford has for some time recommended a
switch from inflation targeting to price level targeting (i.e. from a rate of change to a
level target). The implication of this is that, if the Fed misses its inflation target on
the low side for a while, it would be forced to compensate for this by allowing the
inflation rate to run above the target at a later date.
n mucI oI WoodIord`s prevIous work, Ie Ius urgued LIuL un ouLpuL gup udjusLed
prIce IeveI LurgeL Is opLImuI. MoneLurv poIIcv under sucI u LurgeL wouId be seL so us
to hit a price level target, and would be eased further if output were below potential.
This is near to a Taylor rule, with the price level replacing the inflation rate in the
formula. Because Woodford argues that this form of target is difficult to explain
clearly to the public, his Jackson Hole paper recommends targeting the level of
NGDP instead. Woodford suggests that the two targets might be close to each other
in practice.
12
Why does he think that a NGDP level target approximates his optimal target
framework? He does not explain this in any detail, but it is presumably for the
following reason. Assume that the price level and the level of output are both below
trend, so that NGDP is undershooting its target by the sum of the real output gap
pIus LIe gup beLween LIe prIce IeveI und LIe ed`s LurgeL Ior LIuL vurIubIe. TIe
appropriate policy is then to ease monetary conditions until output has returned to
trend; and then to keep monetary policy easy (by keeping short rates at zero) for as
long as it takes to boost inflation and return the price level to its target. The
implication of this is that short rates would stay at zero after the conventional Taylor
rule would have them increasing. This is the result desired by Woodford, i.e. the
NGDP target results in the Fed keeping rates at zero for longer than standard Fed
policy would imply, and that creates a period of above target inflation.
The problem, though, is that the composition of the shortfall in NGDP is very
different from what the Woodford approach seems to assume.

12
It is worth noting that Sir Samuel Brittan, the Financial Times columnist, has long been an
advocate of NGDP targeting in the UK, though his recommendation has usually been
formulated in terms of growth rates rather than levels.
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 17

n Igure z beIow, PuneI A IIIusLruLes WoodIord`s proposed poIIcv oI LurgeLIng u
linear trend of NGDP, fitted over the years 1990 Q1 - 2008 Q3. The current gap
between NGDP and this trend is around 14%, and growing.
However, none of this gap arises from a gap in the price level relative to its trend.
As panel B shows, the price level is almost exactly at the level indicated by an
extrapolation of its pre-crisis trend line (which in fact rises at about 2% per annum,
LIe ed`s LurgeL ruLe).
Figure 2. Trends in NGDP, the Price Level and Real GDP

Note: logarithmic scales, rebased to 100 at Q4 2007. The linear trend is extrapolated,
following Woodford, using the sample Q1 1990 - Q3 2008. The Price Level measure is the
headline PCE deflator. Potential output is the CBO estimate of (real) potential GDP. Source:
Haver Analytics and Fulcrum calculations.

L Is crucIuI Lo upprecIuLe LIuL, uL LIe presenL LIme, WoodIord`s opLImuI poIIcv oI
targeting the price level would not prescribe additional accommodation coming from
a past shortfall in the price level. This does not seem to have been recognised by
some economists who recommend the use of a NGDP level target.
80
85
90
95
100
105
110
115
120
125
2
0
0
4

2
0
0
6

2
0
0
8

2
0
1
0

2
0
1
2

A. The gap between NGDP and
its trend...
Nominal GDP
2
0
0
4

2
0
0
6

2
0
0
8

2
0
1
0

2
0
1
2

B. ... is not a price level
gap...
Price Level
2
0
0
4

2
0
0
6

2
0
0
8

2
0
1
0

2
0
1
2

C. ... but a gap in real
GDP growth.
Real
GDP
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 18

Where, then, is the 14 percentage point gap in NGDP coming from?
NGDP is simply the price level times real GDP. If the gap is not coming from the
price level, it must be coming from real GDP. As Panel C shows, this is indeed the
case. According to estimates of the Congressional Budget Office (CBO), real GDP
(blue) fell below its potential level (solid grey) during the Great Recession and has
not since then recovered. The real output gap (the difference between real GDP and
its potential level) is still currently around 6%.
But 8 percentage points of the NGDP gap are still to be accounted for. The source of
this is the difference between real potential output (solid grey) and the simple linear
Lrend LIuL WoodIord uses Lo exLrupoIuLe growLI. WoodIord`s exLrupoIuLIon uses LIe
average growth rate of the period 1990-2008, a period of very high real GDP growth.
But the CBO considers that because of various structural factors, potential growth
slowed down since 2000, and especially after 2008.
An inherent practical problem with NGDP targeting is precisely that it ignores that
there might be, from time to time, slowdowns in potential growth. Assume that
CBO`s esLImuLe oI poLenLIuI ouLpuL Is correct, and that the Fed adopts NGDP
LurgeLIng usIng WoodIord`s proposed IIneur Lrend. I LIe unnouncemenL oI LIe new
policy is successful, an increase in inflation expectations would lower real interest
rates, and stimulate the economy immediately.
The real output gap would gradually close but, critically, inflation would initially
remain below or around 2%, since according to economic theory no additional
inflation is generated before the economy operates at full capacity. At the point
where real GDP reaches potential, however, there would still be a large shortfall in
NGDP on WoodIord`s esLImuLe oI LIe gup. Under his NGDP rule, the Fed would
then need to keep to its promise and maintain interest rates fixed at zero, pushing
real GDP above its potential level and spurring high inflation. But this higher
inflation would not close any pre-existing price level gap because, as we pointed out
before, there is no such gap. It would instead mean that the Fed would be producing
a permanently higher price level. Inflation would continue rising for as long as
output remained above its potential level.
It is possible to calculate where this new path for the price level would be using
WoodIord`s NGDP LurgeL IeveI und CBO`s poLenLIuI ouLpuL. n Igure , we pIoL LIe
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 19

current price level (red line), its historical trend (black line), and the price level that
the Fed would be aiming for if it adopted NGDP targeting based on a 14% current gap
(blue line).
13

Figure 3. Which target for the price level?


Source: US Bureau of Economic Analysis, CBO, and Fulcrum calculations.

Adopting such a NGDP target in the present circumstances would imply accepting a
significant upward shift in the price level, relative to its historical 2% trend.
It is difficult to say whether an increase in the path for the price level is what
Woodford and other proponents of NGDP targeting desire, since they have not
explicitly recognised that this problem exists. In fact, Woodford (p. 83) seems
confident that adopting NGDP targeting

13
TIe ImpIIed prIce IeveI Is expressed In Lerms oI LIe GDP deIIuLor und Is cuIcuIuLed us LIe
ruLIo beLween LIe IIneur Lrend proposed bv WoodIord und CBO`s meusure oI poLenLIuI reuI
output. The price level shown is the GDP deflator. We follow Woodford in using the sample
1990 Q1 - 2008 Q3 to extrapolate its historical path trend.
Price level
target
implied by
NGDP trend
Historical 2%
trend for the
price level
80
90
100
110
120
2003 2005 2007 2009 2011 2013
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 20

does not imply any intention to tolerate continuing inflation above the Fed's
declared long-run inflation target - that in fact, it will not lead to a future level of
nominal income any higher than what people had reason to anticipate at the time
that they acquired their existing nominal assets and undertook their existing
nomincl obliqctions.
There is another, even longer term, problem with this approach. Faced with rising
inflation and output above trend, the Fed would eventually decide it needs to choke
off the rise in inflation through raising interest rates and tightening monetary policy.
This would mean pushing the economy into recession-or, at least, growth below its
trend rate for a period-to generate disinflationary pressure and lower inflation
expectations. If the Fed announced a Woodford-type NGDP target in the near future,
investors would start to calculate how this would evolve, and realise a recession
would follow the future boom. They would factor in the future higher interest rates
following the period of lower rates. This would itself undermine the stimulus given to
the economy in the present period.
These problems all arise essentially because there is no price level gap for the Fed to
eIImInuLe uL LIe presenL LIme, und becuuse WoodIord`s purLIcular formulation of the
NGDP LurgeL wouId resuIL In reuI GDP beIng pusIed ubove LIe CBO`s esLImuLe oI
potential output.
14
Proponents of the NGDP target might reject this analysis by
dIsugreeIng wILI CBO`s cuIcuIuLIon oI poLenLIuI ouLpuL und, LIereIore, LIe size of the
output gap. Indeed, potential output is not directly observable, and its estimation is
subject to a large amount of controversy and uncertainty. These are problems which
arise with many different ways of setting monetary policy frameworks, not just a
NGDP framework.
Woodford (p. 46) himself points out that

14
These problems have been noticed inside the FOMC. James Bullard, President of the St.
Louis Federal Reserve Bank, has recently released a presentation which points out that there
is no price level gap for the Fed to exploit, and that the level and growth rate of potential GDP
may have been reduced by the effects of the financial crisis. He argues that an attempt by the
Fed to follow a Woodford NGDP target would simply result in higher inflation. (See Bullard,
J. (zo1z) A Singular AchievemenL oI RecenL MoneLurv PoIIcv, presented at Theodore and
Rita Combs Distinguished Lecture Series in Economics, University of Notre Dame.)
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 21

if consensus could be reached about the path of potential output, it would be
desirable in principle to adjust the target path for nominal GDP to account for
variations over time in the growth of potential.
But whatever measure of the output gap one uses to define target GDP confronts the
problem that the price level is not materially below its historical trend line.
There is another implication of NGDP targeting that relates to the uncertainty
surrounding estimation of potential output. Different institutions come up with
different estimates of the output gap-there is no guarantee the CBO estimate is
correct. In terms of Figure 3, it would mean that there would be uncertainty about
LIe ImpIIed prIce IeveI LurgeL und, In prucLIce, uncerLuInLv ubouL LIe umounL oI
inflation needed to reach it. As mentioned earlier, inflation uncertainty hurts the
economy.

7KH)HGVDWWLWXGHWRZDUGVWKH:RRGIRUGSURSRVDOV
Many commentators suggest that the FOMC has been significantly influenced by the
thinking of Woodford. Indeed, some have viewed the September FOMC statement as
a clear step on the road to a NGDP level target, especially since Chairman Bernanke
spontaneously mentioned a NGDP target when talking about Woodford during his
September press conference.
However, Bernanke was very careful in his choice of words, and it is important to
note that he did not say that the Fed was considering a NGDP level target, or that it
would tolerate a prolonged period in which inflation was significantly above the 2%
medium-term target. On a close inspection of what the Fed actually said and did in
September, there is still a very large difference between the stated approach of the
central bank and the thinking of Michael Woodford.
First, there is a profound disagreement between the Woodford view on the
effectiveness of balance sheet policies, und LIe ed`s vIew. As expIuIned ubove,
Woodford believes that bond purchases by the central bank are ineffective, except in
so far as they change expectations about the future path of short rates. Therefore they
ure busIcuIIv purL oI LIe cenLruI bunk`s Iorwurd guIdunce poIIcv. TIIs sLems Irom
WoodIord`s sympathy for the concept of Wallace neutrality and his belief that
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 22

investors can switch easily between assets. In contrast, the Fed believes (and has said
on multiple occasions) that asset purchases work through portfolio balance effects,
which enable it to alter asset prices and reduce bond yields by engaging in asset
purchase programmes. It has never given even the mildest of nods in the direction of
Wallace neutrality.
This difference of opinion on theory is accompanied by an equally important
difference on the empirical evidence about the effects of the asset purchase
progrummes sInce zoo. WoodIord`s InLerpreLuLIon oI LIe empIrIcuI evIdence Is LIuL
it concludes that the programmes have been largely ineffective, while the Fed and its
Chairman frequently quote evidence which attributes large economic gains to the
effects of the programmes.
This difference is crucial for future policy, since it predisposes the Fed to believe that
further easing through such programmes is likely to be effective, while Woodford
would deny this and therefore looks for other alternatives.
Turning to forward guidance, it is clear that the Fed sees a very important role for
this arm of policy, and to that extent they agree with the Woodford approach. Indeed,
in his September press conference, Bernanke went to great lengths to say that he
ugreed wILI WoodIord LIuL credibility is the key tool that central banks have in
order to get traction at the zero lower bound. That, however, is just about as far as
the agreement seems to go.
As we have noted, the Woodford proposals on forward commitment have two key
ingredients. The first is that forward guidance on interest rates (and presumably the
sIze oI LIe buIunce sIeeL) sIouId noL be expressed us LIe ed`s currenL expecLuLIons oI
the forward path for the policy variables, gIven LIe ed`s currenL economIc IorecusLs.
Instead, the Fed should express a firm commitment to keep low rates in place until
certain economic conditions are met. Second, Woodford says that policy should
become history dependent, so that the Fed would commit itself to compensate for
any under-shooting in the path for the target variable by trying to catch up later to
the original path. Those two ingredients, says Woodford, can be expressed in terms
of a path for the level of NGDP.
Bernanke expressed the key to this approach in his press conference as follows:
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 23

The implication [is] that the Fed would target the nominal level of GDP and
promise to do that for many years in the future even if inflation, you know, rose as
part of that policy.
The Chairman therefore accepts that the key to the entire Woodford approach is that
it would involve the Fed giving a commitment that it intended to permit a period of
above-target inflation in order to compensate for earlier undershooting of the level of
NGDP from its target path. Furthermore, it would tolerate this period of above target
InIIuLIon even LIougI, wIen LIe LIme cume, IL wouId be In LIe ed`s (und In LIe
pubIIc`s) InLeresL Lo ubundon ILs eurIIer promIse, und LIgILen poIIcv unvwuv.
Has the Fed shown any inclination to adopt either of these two key tenets of the
Woodford approach? The answer is not much. Admittedly, in the September FOMC
sLuLemenL, LIev Iuve suId LIuL LIev expecL a highly accommodative stance of
monetary policy will remain appropriate for a considerable time after the economic
recovery strengthens. TIIs empIusIses LIuL LIe exLensIon oI LIe Iorwurd guIdunce
Ius noL occurred jusL becuuse LIe ed`s IorecusL oI LIe economIc ouLIook Ius
worsened, wIIcI uccords wILI one oI WoodIord`s concerns. BuL the policy guidance is
still only an expectation, not a formal commitment.
They have also said:
I[ the outlool [or the lcbour mcrlet does not improte substcnticllu, the Committee
will continue its purchases of agency mortgage-backed securities, undertake
additional asset purchases, and employ its other policy tools as appropriate until
such improvement is achieved in a context of price stability.
This is a step towards the Woodford approach, because it gives economic conditions,
related to employment, which need to be met before the Fed would stop expanding
the size of the balance sheet. But the key is that the Fed has certainly not promised to
keep the policy accommodation in place if inflation runs for a considerable period
above 2%. In fact, the words In LIe conLexL oI prIce sLubIIILv poInL In enLIreIv LIe
opposite direction. Still less has the Fed promised to target a path for the level of
NGDP, or the price level, which would mean that at some point in the future it would
keep short rates lower than a future FOMC would prefer, given the circumstances of
the day.
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 24

Instead, the Fed seems to be saying that it expects to keep policy highly
accommodative until the labour market has improved substantially, and that it also
expects that this will be consistent with continuing to meet its inflation objectives.
TIIs wus empIusIsed bv LIe IucL LIuL LIe cenLruI Lendencv oI LIe OMC`s IorecusLs Ior
price inflation remain below 2% throughout the period from now to the end of 2015,
as shown in Figure 4.
Figure 4. OMC purLIcIpunL`s projecLIons oI unempIovmenL und InIIuLIon

Note: Dcrl cnd liqht blue crecs represent the centrcl tendencu cnd the rcnqe o[ the IDMC's
projections for the two variables, while dashed lines represent their long-run targets, expressed as a
range for the unemployment rate. Source: Federal Reserve Board.

The Fed does not seem to see a conflict between the unemployment and inflation
objectives which appear in its twin mandate; it believes that more accommodative
policy will reduce unemployment without increasing inflation.
In the context of Figure 2 in the previous section, the Fed seems to be saying that it
can increase real output by (say) the 6% needed to take it back to its potential level in
panel C, while keeping the price level on its 2% target path in panel B. In sharp
contrast to the Woodford recommendation, policy would then go back to normal.
There would be no need for a period of inflation above target, and no period in which
policy would be held easier than implied by a standard Taylor rule.
0%
2%
4%
6%
8%
10%
12%
2005 2007 2009 2011 2013 2015
a. Unemployment Rate
-2%
-1%
0%
1%
2%
3%
4%
5%
2005 2007 2009 2011 2013 2015
b. Consumer Price Inflation
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 25

NoLe LIuL LIe ed`s beIIeI LIuL IL cun reduce unempIovmenL wILIouL ruIsIng InIIuLIon
is ucLuuIIv u verv KevnesIun beIIeI, wIIcI ussumes LIuL, wIen LIe IeveI oI ouLpuL Is
below potential, the first effects of easier monetary policy will be felt in higher real
output, not higher prices. This is in very sharp conLrusL wILI LIe worrIes oI LIe ed`s
Republican critics, who argue that monetary accommodation might raise inflation
without reducing unemployment.
We do not know for sure how much tolerance the Fed would have for temporarily
higher inflation if there were an adverse inflation shock. But we can surmise that the
crucIuI words In LIe conLexL oI prIce sLubIIILv meun LIuL LIe ed wouId need Lo see
progress towards a return to its 2% inflation target in the longer run, and stability of
inflation expectations in the meantime. This bears almost no resemblance to the
Woodford recommendation to increase inflation expectations deliberately so that
real interest rates fall. In fact, it bears more resemblance to the flexible inflation
targeting which is followed by the Bank of England and, in practice, the ECB.
There are probably some very good reasons why the Fed and its Chairman have been
unwilling to take anything more than a few tentative steps down the road which
Woodford recommends. Bernanke has always been very concerned to keep control
over inflation expectations, and does not want to inject any significant amount of
inflation uncertainty into the economy. He emphasised this in his April press
conference, when he said it would be
reclless to ...cctitelu seel c hiqher in[lction rcte in order to cchiete c sliqhtlu
increcsed.pcce o[ reduction in the unemploument rcte.
This is a very different stance from that implicitly built into the Woodford approach.
In IucL, LIe IuLLer`s models do not include any role for inflation uncertainty to damage
the economy.
In addition, there may well be institutional reasons why Bernanke has been reluctant
to embrace a NGDP IeveI LurgeL. SucI u LurgeL requIres Loduv`s ed Lo commit the
actions of its successors, even when those actions will not be in the interests of the
successors themselves. It is very debatable whether such commitments would be
credIbIe In LIe murkeL`s eves. I LIev ure noL credIbIe, LIen, us dIscussed ubove, they
would not work, in which case the NGDP level target may deviate more and more
each year from actual GDP. This could expose the Fed as impotent in the face of
G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 26

recession, which would scarcely be helpful. Finally, the Chairman would be most
unlikely to obtain wide agreement on the FOMC for a target which implicitly or
explicitly permits the rate of inflation to exceed 2% for lengthy periods, especially
since the inflation target itself was only unveiled for the first time in January of this
year.

Conclusion
n summurv, LIe gup beLween LIe ed`s currenL LIInkIng, und MIcIueI WoodIord`s
recommenduLIons, Is sLIII verv Iurge. Our InLerpreLuLIon oI LIe ed`s recenL ucLIons Is
that they believe that the margin of spare capacity in the economy is substantial, and
that monetary accommodation can therefore reduce unemployment without raising
inflation much, if at all, above the 2% longer run objective. They also appear to
believe that asset purchases have been effective in the past, and will continue to have
a key role in impacting the economy in the future. They are not deliberately trying to
raise inflation expectations in order to reduce real interest rates, as Woodford would
recommend. Nor have they been willing to commit their successors to accommodate
above-target inflation in the future in order to hit a NGDP level target set many years
earlier. A NGDP level target remains as a last resort option for the Fed, but only if
economic conditions worsen considerably further from here. In summary, we believe
that the markets may be underestimating the fundamental nature of the continuing
intellectual divide which exists between the Fed`s IeudersIIp and Professor
Woodford.

G. Davies et al, Professor Woodford and the Fed



Fulcrum Research Papers - October 2012 27

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