Inverse Optimal Control Monetary Policy

Re-calibrating Yellen's lower for longer playbook

When Janet Yellen was the Fed Chair from 2014 to 2018, some of her mostly dovish concepts came to the forefront when anticipating future monetary policy stances. I studied her academic views regarding rules-based monetary policy strategies in detail, as it showed me how far they will likely go in keeping rates lower for longer. It was one part of my long-held long bond thesis back then.

Especially her speech in 2012, when she was vice-chair, was one that set the tone for much of the dovish policy stance even as they started lifting rates in December 2015. I remember the exact moment back then I was wearing the below t-shirt for lift-off.

As much as taking rates finally higher from the zero floor, the Fed’s reaction function meant only good things for bonds. A slow and steady, overly cautious approach to monetary policy. This was mostly related to Yellen’s “Optimal Control” policy which she outlined in her above-mentioned speech in 2012. You can find the link here. It is very theoretical but worth exploring, especially as we are currently facing the opposite mix. High nominal growth and inflation. What would “Inverse Optimal Control” look like? Let’s dig in …