Just What Is John Taylor Thinking?
For the past decade Stanford's John Taylor has been loudly crying:
- It is very important for central banks to follow the original Taylor rule, as I derived it assuming that the effects of monetary policy are close to consensus estimates.
- In particular, allowing interest rates to fall below my original Taylor rule values generates enormous trouble, because the effects of monetary policy on the economy are much larger than consensus estimates.
And we all have said: This makes no sense! If the original derivation of the Taylor rule is accurate, minor deviations from it have small consequences. If minor deviations from optimal policy rules have major consequences, than the original Taylor rule simply cannot be the optimal policy rule.
And we have never gotten a coherent answer.
In my inbox this morning the very sharp David Glasner and Paul Krugman express other frustrations:
...and very likely the next Chairman of the Federal Reserve Board if a Republican is elected President of the United States in 2016.... The Hayek Prize of the Manhattan Institute in 2012 for his book First Principles: Five Keys to Restoring America’s Prosperity... invoked Hayek’s Road to Serfdom and his Constitution of Liberty... but Professor Taylor... was obviously not interested enough to read Hayek’s chapter on monetary policy.... If he had he could not possibly have made the following assertions....
Rules for monetary policy do not mean that the central bank does not change the instruments of policy (interest rates or the money supply) in response to events, or provide loans in the case of a bank run. Rather they mean that they take such actions in a predictable manner.
But guess what. Hayek took a view rather different....
The [validity of the] argument against discretion in monetary policy rests... on whether we can devise an automatic mechanism which will make the effective supply of money change in a more predictable and less disturbing manner than will any discretionary measures likely to be adopted. The answer is not certain....
Quoting Hayek as an authority for a position that Hayek explicitly declined to take in the very source invoked by Professor Taylor. But that was just Professor Taylor’s teaser.... Things got even worse in the lecture--much worse. I mean disastrously worse...
And here, with Paul Krugman providing quotes from Jaime Caruana rather than similar quotes from John Taylor:
but... it is definitely relevant to note that the people making the financial stability argument for higher rates are permahawks, who keep coming up with new justifications for an unchanging policy demand.... Originally (2011), the BIS demanded rate hikes to head off the alleged threat of inflation....
‘Tighter global monetary policy is needed in order to contain inflation pressures and ward off financial stability risks,’ the BIS said in its annual report published yesterday in Basel, Switzerland. ‘Central banks may have to be prepared to raise policy rates at a faster pace than in previous tightening episodes.’... ‘The world economy is growing at a historically respectable rate of around 4 percent,’ Caruana said. ‘The resurgence of demand has put concerns about deflation behind us. Accordingly, the need for continued extraordinary monetary accommodation has faded.’...
The inflation warning proved wrong.... You might expect some reconsideration.... Instead, however, you get new reasons for the same policy:
BIS' Caruana Warns Low Interest Rate Environment Allows Reforms to Be Postponed: BIS chief warns regulators may be "fighting the last war", and calls for central bankers to push for a "return to sustainable government finances"...
BIS' Caruana Warns of Low Interest Rates Risk: Jaime Caruana says low interest rates have created a "first mover disadvantage" that prevents rates rising and could fuel financial instability...
Note that suggestion that easy money reduces the incentive for ‘reform’... that the Fed’s [and the ECB's] policies have prevented the crisis they were sure was imminent as a result of liberal big spending.... Ben Bernanke did us a bit of a disservice by not linking to whoever it is he’s arguing with. It would help to know that John Taylor and the BIS are on the other side, because this would let readers place their position here in context with their other positions.
As I have said before, John Taylor (and Jaime Caruana) are not setting out a model of the economy and then trying to figure out what policies advance societal welfare. Rather, they know what policies advance societal welfare and are trying--without much success, and without any coherence--to cobble together pieces of economic models that will provide some justification for the policies chosen ex ante.
How to have a constructive dialogue with people engaged in such an extreme version of motivated reasoning is a problem that I do not know how to solve.
