On John Taylor’s defence of the Taylor Rule bill

This post responds, though JT directs his fire at Paul Krugman, not myself.

JT points out that the legislation isn’t designed to pressure the Fed to follow the Taylor Rule. This defence is hollow. JT thinks the crisis was caused by deviating from it, and supports the legislation. Even in the same post he refers to research extolling its performance in macro models. Clearly he thinks future Fed policy would improve, the appropriate metric being closeness to the Taylor Rule. Asserting that it would not get him everything he wants does not refute the main point.

JT makes reference in support of his Bill to the literature on rules versus discretion. I think this does him no favours for a few reasons.

First, we have to dispense with the part of that literature that concerns itself with the tendency for pure discretion to induce too high levels of average inflation. That’s not at issue here given the Feds price stability mandate.

The relevant part concerns how to eliminate the ‘stabilisation bias’, the tendency for discretion to induce ineffective over-smoothing of the cycle.

Studies do show a benefit of commitment over discretion. But these benefits are not that large and its arguable whether they can be achieved.

Even more contentious is whether suboptimal policy under commitment (Taylor rule) dominates optimal policy under discretion. I’d guess it would be a close run thing.

Finally, the dynamic rules versus discretion comparison is conducted under certainty. Under something that captured the profound model uncertainty the crisis revealed, these benefits could well disappear.

JT does not address the concern that his legislation makes it easier for political and discretionary interference to be brought to bear on operational matters. It erodes Fed independence over policy conduct, judged bad by reasoning from the rules versus discretion logic. Less fed discretion, more political discretion.

JT also defends his TR agenda against the accusation that the zero bound was not ignored. But he does not respond to the observation that theoretically at least religious adherence to the TR induces a trap at that bound. It’s easy to dismiss this concern: the model (in which ignoring the bad steady state gives good performance for the TR) is not nearly true. But then we have to reduce our confidence in the rule’s appropriateness.

JT continues to maintain that the crisis was caused by TR deviancy. Yet the models in which the TR does well have no financial sector that could produce systemic financial crises. Those models suggest TR deviancy has small and short lasting effects that many economist would dismiss (not me actually) as not worth bothering about. But they can’t produce 2 decade long Real balance sheet and leverage accumulation, followed by a bust.

Repeating my earlier points, the crisis does not teach us about the costs of TR deviancy, it reminded us that we are much further than we thought from having perfected what used to be dubbed a ‘science of monetary policy’, and nowhere near the point where an institution could credibly commit, on the basis of sound evidence, to a monetary policy rule.

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One Response to On John Taylor’s defence of the Taylor Rule bill

  1. JT was advocating fiscal stimulus in 2003 despite his counterfactual Fed Funds rate suggesting that the Fed should have been raising rates from the end of 2001. I cannot find any evidence of him saying in 2002-2004 that the fed funds rate was “too low”. That’s understandable, its hard to find anyone (most, like Rogoff, actually argued that there wasn’t enough monetary stimulus). But are we really supposed to believe that the Fed should have started tightening 18mths before the Bush stimulus in 2003, which Taylor partially orchestrated? How does he incorporate fiscal policy? Like so much of monetary policy today, there is an illusion of control and implausible sophistication. It would be interesting to know what the standard error in the measurement of inflation is. I wouldn’t be surprised if we discover that the Fed wasn’t actually mapping a Taylor rule in the 80s & 90s because inflation was mis-measured. I am guessing, Tony, but if measurement error is causing inflation to be over-estimated and real output/trend growth to be underestimated, applying the Taylor rule compounds this error?

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