Must-Read: Noah Smith: Taylor and His Rule Are Not What the Fed Needs

Must-Read: Endorse. The biggest reason not to name John Taylor to run the Fed is his persistent refusal to take any steps to mark his beliefs to market—to perform any kind of view-updating exercise in response to the extraordinary economic troubles of the past decade. That is just not right for anyone claiming to be an economist. And that is doubly not right for anyone being considered for any senior policymaking position. If Taylor is nominated, the Senate Banking Committee should not confirm him:

Noah Smith: Taylor and His Rule Are Not What the Fed Needsg: “How much should the Fed worry about inflation versus unemployment?…

The Taylor Rule contains two number…. When Taylor made the rule, he rather arbitrarily set both values to be 0.5…. When compared to the numbers Taylor picked, it looks like the Fed assigns more weight to unemployment and less to inflation. The Fed’s approach seemed to work fairly well in the 1980s and 1990s…. Only in the Great Recession did this approach seem inadequate — the Fed lowered rates all the way to zero, at which point it could lower them no further (since nominal interest rates can’t go much below zero). Taylor, however, would have done things differently. In a blog post in June 2011 — when interest rates were at zero and the Federal Reserve was contemplating engaging in further rounds of quantitative easing — Taylor wrote that the Fed ought to raise rates instead….

Taylor’s recommendation relied on his original rule, with its original arbitrary round numbers. That rule recommended raising interest rates above zero as early as 2010, and would have had rates at almost 4 percent in 2012. The Fed didn’t take Taylor’s advice. Instead, it kept rates at zero, and continued its program of QE. Inflation, which Taylor warned about, failed to appear. Taylor also warned of financial market volatility if interest rates weren’t raised. But that also failed to appear…. It’s safe to say that the outcome was fairly good. And none of the dangers that Taylor prophesied came to pass.

One would think that Taylor would have reconsidered his more hawkish policy rule in light of these developments. But he continued to defend his version of the rule, and to criticize the Fed’s actions, years later. This apparent refusal to revise his views, combined with a general reputation for monetary hawkishness, probably goes a long way toward explaining why Taylor appeals to the Trump White House…. As Fed chief, it’s impossible to know in advance if Taylor would live up to these expectations of hawkishness…. But if Taylor did let himself be significantly influenced by the rule that bears his name, it would almost certainly push him to raise interest rates above what other Fed leaders like Yellen might choose. And that would pose a danger to the real economy.

October 19, 2017


Brad DeLong
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