Archive for the 'John Taylor' Category

Cluelessness about Strategy, Tactics and Discretion

In his op-ed in the weekend Wall Street Journal, John Taylor restates his confused opposition to what Ben Bernanke calls the policy of constrained discretion followed by the Federal Reserve during his tenure at the Fed, as vice-chairman under Alan Greenspan from 2003 to 2005 and as Chairman from 2005 to 2013. Taylor has been arguing for the Fed to adopt what he calls the “rules-based monetary policy” supposedly practiced by the Fed while Paul Volcker was chairman (at least from 1981 onwards) and for most of Alan Greenspan’s tenure until 2003 when, according to Taylor, the Fed abandoned the “rules-based monetary rule” that it had followed since 1981. In a recent post, I explained why Taylor’s description of Fed policy under Volcker was historically inaccurate and why his critique of recent Fed policy is both historically inaccurate and conceptually incoherent.

Taylor denies that his steady refrain calling for a “rules-based policy” (i.e., the implementation of some version of his beloved Taylor Rule) is intended “to chain the Fed to an algebraic formula;” he just thinks that the Fed needs “an explicit strategy for setting the instruments” of monetary policy. Now I agree that one ought not to set a policy goal without a strategy for achieving the goal, but Taylor is saying that he wants to go far beyond a strategy for achieving a policy goal; he wants a strategy for setting instruments of monetary policy, which seems like an obvious confusion between strategy and tactics, ends and means.

Instruments are the means by which a policy is implemented. Setting a policy goal can be considered a strategic decision; setting a policy instrument a tactical decision. But Taylor is saying that the Fed should have a strategy for setting the instruments with which it implements its strategic policy.  (OED, “instrument – 1. A thing used in or for performing an action: a means. . . . 5. A tool, an implement, esp. one used for delicate or scientific work.”) This is very confused.

Let’s be very specific. The Fed, for better or for worse – I think for worse — has made a strategic decision to set a 2% inflation target. Taylor does not say whether he supports the 2% target; his criticism is that the Fed is not setting the instrument – the Fed Funds rate – that it uses to hit the 2% target in accordance with the Taylor rule. He regards the failure to set the Fed Funds rate in accordance with the Taylor rule as a departure from a rules-based policy. But the Fed has continually undershot its 2% inflation target for the past three years. So the question naturally arises: if the Fed had raised the Fed Funds rate to the level prescribed by the Taylor rule, would the Fed have succeeded in hitting its inflation target? If Taylor thinks that a higher Fed Funds rate than has prevailed since 2012 would have led to higher inflation than we experienced, then there is something very wrong with the Taylor rule, because, under the Taylor rule, the Fed Funds rate is positively related to the difference between the actual inflation rate and the target rate. If a Fed Funds rate higher than the rate set for the past three years would have led, as the Taylor rule implies, to lower inflation than we experienced, following the Taylor rule would have meant disregarding the Fed’s own inflation target. How is that consistent with a rules-based policy?

It is worth noting that the practice of defining a rule in terms of a policy instrument rather than in terms of a policy goal did not originate with John Taylor; it goes back to Milton Friedman who somehow convinced a generation of monetary economists that the optimal policy for the Fed would be to target the rate of growth of the money supply at a k-percent annual rate. I have devoted other posts to explaining the absurdity of Friedman’s rule, but the point that I want to emphasize now is that Friedman, for complicated reasons which I think (but am not sure) that I understand, convinced himself that (classical) liberal principles require that governments and government agencies exercise their powers only in accordance with explicit and general rules that preclude or minimize the exercise of discretion by the relevant authorities.

Friedman’s confusions about his k-percent rule were deep and comprehensive, as a quick perusal of Friedman’s chapter 3 in Capitalism and Freedom, “The Control of Money,” amply demonstrates. In practice, the historical gold standard was a mixture of gold coins and privately issued banknotes and deposits as well as government banknotes that did not function particularly well, requiring frequent and significant government intervention. Unlike, a pure gold currency in which, given the high cost of extracting gold from the ground, the quantity of gold money would change only gradually, a mixed system of gold coin and banknotes and deposits was subject to large and destabilizing fluctuations in quantity. So, in Friedman’s estimation, the liberal solution was to design a monetary system such that the quantity of money would expand at a slow and steady rate, providing the best of all possible worlds: the stability of a pure gold standard and the minimal resource cost of a paper currency. In making this argument, as I have shown in an earlier post, Friedman displayed a basic misunderstanding of what constituted the gold standard as it was historically practiced, especially during its heyday from about 1880 to the outbreak of World War I, believing that the crucial characteristic of the gold standard was the limitation that it imposed on the quantity of money, when in fact the key characteristic of the gold standard is that it forces the value of money – regardless of its material content — to be equal to the value of a specified quantity of gold. (This misunderstanding – the focus on control of the quantity of money as the key task of monetary policy — led to Friedman’s policy instrumentalism – i.e., setting a policy rule in terms of the quantity of money.)

Because Friedman wanted to convince his friends in the Mont Pelerin Society (his egregious paper “Real and Pseudo Gold Standards” was originally presented at a meeting of the Mont Pelerin Society), who largely favored the gold standard, that (classical) liberal principles did not necessarily entail restoration of the gold standard, he emphasized a distinction between what he called the objectives of monetary policy and the instruments of monetary policy. In fact, in the classical discussion of the issue by Friedman’s teacher at Chicago, Henry Simons, in an essay called “Rules versus Authorities in Monetary Policy,” Simons also tried to formulate a rule that would be entirely automatic, operating insofar as possible in a mechanical fashion, even considering the option of stabilizing the quantity of money. But Simons correctly understood that any operational definition of money is necessarily arbitrary, meaning that there will always be a bright line between what is money under the definition and what is not money, even though the practical difference between what is on one side of the line and what is on the other will be slight. Thus, the existence of near-moneys would make control of any monetary aggregate a futile exercise. Simons therefore defined a monetary rule in terms of an objective of monetary policy: stabilizing the price level. Friedman did not want to settle for such a rule, because he understood that stabilizing the price level has its own ambiguities, there being many ways to measure the price level as well as theoretical problems in constructing index numbers (the composition and weights assigned to components of the index being subject to constant change) that make any price index inexact. Given Friedman’s objective — demonstrating that there is a preferable alternative to the gold standard evaluated in terms of (classical) liberal principles – a price-level rule lacked the automatism that Friedman felt was necessary to trump the gold standard as a monetary rule.

Friedman therefore made his case for a monetary rule in terms of the quantity of money, ignoring Simons powerful arguments against trying to control the quantity of money, stating the rule in general terms and treating the selection of an operational definition of money as a mere detail. Here is how Friedman put it:

If a rule is to be legislated, what rule should it be? The rule that has most frequently been suggested by people of a generally liberal persuasion is a price level rule; namely, a legislative directive to the monetary authorities that they maintain a stable price level. I think this is the wrong kind of a rule [my emphasis]. It is the wrong kind of a rule because it is in terms of objectives that the monetary authorities do not have the clear and direct power to achieve by their own actions. It consequently raises the problem of dispersing responsibilities and leaving the authorities too much leeway.

As an aside, I note that Friedman provided no explanation of why such a rule would disperse responsibilities. Who besides the monetary authority did Friedman think would have responsibility for controlling the price level under such a rule? Whether such a rule would give the monetary authorities “too much leeway” is of course an entirely different question.

There is unquestionably a close connection between monetary actions and the price level. But the connection is not so close, so invariable, or so direct that the objective of achieving a stable price level is an appropriate guide to the day-to-day activities of the authorities. (p. 53)

Friedman continues:

In the present state of our knowledge, it seems to me desirable to state the rule in terms of the behavior of the stock of money. My choice at the moment would be a legislated rule instructing the monetary authority to achieve a specified rate of growth in the stock of money. For this purpose, I would define the stock of money as including currency outside commercial banks plus all deposits of commercial banks. I would specify that the Reserve System shall see to it [Friedman’s being really specific there, isn’t he?] that the total stock of money so defined rises month by month, and indeed, so far as possible day by day, at an annual rate of X per cent, where X is some number between 3 and 5. (p. 54)

Friedman, of course, deliberately ignored, or, more likely, simply did not understand, that the quantity of deposits created by the banking system, under whatever definition, is no more under the control of the Fed than the price level. So the whole premise of Friedman’s money supply rule – that it was formulated in terms of an instrument under the immediate control of the monetary authority — was based on the fallacy that quantity of money is an instrument that the monetary authority is able to control at will.

I therefore note, as a further aside, that in his latest Wall Street Journal op-ed, Taylor responded to Bernanke’s observation that the Taylor rule becomes inoperative when the rule implies an interest-rate target below zero. Taylor disagrees:

The zero bound is not a new problem. Policy rule design research took that into account decades ago. The default was to move to a stable money growth regime not to massive asset purchases.

Taylor may regard the stable money growth regime as an acceptable default rule when the Taylor rule is sidelined at the zero lower bound. But if so, he is caught in a trap of his own making, because, whether he admits it or not, the quantity of money, unlike the Fed Funds rate, is not an instrument under the direct control of the Fed. If Taylor rejects an inflation target as a monetary rule, because it grants too much discretion to the monetary authority, then he must also reject a stable money growth rule, because it allows at least as much discretion as does an inflation target. Indeed, if the past 35 years have shown us anything it is that the Fed has much more control over the price level and the rate of inflation than it has over the quantity of money, however defined.

This post is already too long, but I think that it’s important to say something about discretion, which was such a bugaboo for Friedman, and remains one for Taylor. But the concept of discretion is not as simple as it is often made out to be, especially by Friedman and Taylor, and if you are careful to pay attention to what the word means in ordinary usage, you will see that discretion does not necessarily, or usually, refer to an unchecked authority to act as one pleases. Rather it suggests that a certain authority to make a decision is being granted to a person or an official, but the decision is to be made in light of certain criteria or principles that, while not fully explicit, still inform and constrain the decision.

The best analysis of what is meant by discretion that I know of is by Ronald Dworkin in his classic essay “Is Law a System of Rules?” Dworkin discusses the meaning of discretion in the context of a judge deciding a “hard case,” a case in which conflicting rules of law seem to be applicable, or a case in which none of the relevant rules seems to fit the facts of the case. Such a judge is said to exercise discretion, because his decision is not straightforwardly determined by the existing set of legal rules. Legal positivists, against whom Dworkin was arguing, would say that the judge is able, and called upon, to exercise his discretion in deciding the case, meaning, that by deciding the case, the judge is simply imposing his will. It is something like the positivist view that underlies Friedman’s intolerance for discretion.

Countering the positivist view, Dworkin considers the example of a sergeant ordered by his lieutenant to take his five most experienced soldiers on patrol, and reflects on how to interpret an observer’s statement about the orders: “the orders left the sergeant a great deal of discretion.” It is clear that, in carrying out his orders, the sergeant is called upon to exercise his judgment, because he is not given a metric for measuring the experience of his soldiers. But that does not mean that when he chooses five soldiers to go on patrol, he is engaging in an exercise of will. The decision can be carried out with good judgment or with bad judgment, but it is an exercise of judgment, not will, just as a judge, in deciding a hard case, is exercising his judgment, on a more sophisticated level to be sure than the sergeant choosing soldiers, not just indulging his preferences.

If the Fed is committed to an inflation target, then, by choosing a setting for its instrumental target, the Fed Funds rate, the Fed is exercising judgment in light of its policy goals. That exercise of judgment in pursuit of a policy goal is very different from the arbitrary behavior of the Fed in the 1970s when its decisions were taken with no clear price-level or inflation target and with no clear responsibility for hitting the target.

Ben Bernanke has described the monetary regime in which the Fed’s decisions are governed by an explicit inflation target and a subordinate commitment to full employment as one of “constrained discretion.” When using this term, Taylor always encloses it in quotations markets, apparently to suggest that the term is an oxymoron. But that is yet another mistake; “constrained discretion” is no oxymoron. Indeed, it is a pleonasm, the exercise of discretion usually being understood to mean not an unconstrained exercise of will, but an exercise of judgment in the light of relevant goals, policies, and principles.

PS I apologize for not having responded to comments recently. I will try to catch up later this week.

What Is the Historically Challenged, Rule-Worshipping John Taylor Talking About?

A couple of weeks ago, I wrote a post chiding John Taylor for his habitual verbal carelessness. As if that were not enough, Taylor, in a recent talk at the IMF, appearing on a panel on monetary policy with former Fed Chairman Ben Bernanke and the former head of the South African central bank, Gill Marcus,  extends his trail of errors into new terrain: historical misstatement. Tony Yates and Paul Krugman have already subjected Taylor’s talk to well-deserved criticism for its conceptual confusion, but I want to focus on the outright historical errors Taylor blithely makes in his talk, a talk noteworthy, apart from its conceptual confusion and historical misstatements, for the incessant repetition of the meaningless epithet “rules-based,” as if he were a latter-day Homeric rhapsodist incanting a sacred text.

Taylor starts by offering his own “mini history of monetary policy in the United States” since the late 1960s.

When I first started doing monetary economics . . ., monetary policy was highly discretionary and interventionist. It went from boom to bust and back again, repeatedly falling behind the curve, and then over-reacting. The Fed had lofty goals but no consistent strategy. If you measure macroeconomic performance as I do by both price stability and output stability, the results were terrible. Unemployment and inflation both rose.

What Taylor means by “interventionist,” other than establishing that he is against it, is not clear. Nor is the meaning of “bust” in this context. The recession of 1970 was perhaps the mildest of the entire post-World War II era, and the 1974-75 recession was certainly severe, but it was largely the result of a supply shock and politically imposed wage and price controls exacerbated by monetary tightening. (See my post about 1970s stagflation.) Taylor talks about the Fed’s lofty goals, but doesn’t say what they were. In fact in the 1970s, the Fed was disclaiming responsibility for inflation, and Arthur Burns, a supposedly conservative Republican economist, appointed by Nixon to be Fed Chairman, actually promoted what was then called an “incomes policy,” thereby enabling and facilitating Nixon’s infamous wage-and-price controls. The Fed’s job was to keep aggregate demand high, and, in the widely held view at the time, it was up to the politicians to keep business and labor from getting too greedy and causing inflation.

Then in the early 1980s policy changed. It became more focused, more systematic, more rules-based, and it stayed that way through the 1990s and into the start of this century.

Yes, in the early 1980s, policy did change, and it did become more focused, and for a short time – about a year and a half – it did become more rules-based. (I have no idea what “systematic” means in this context.) And the result was the sharpest and longest post-World War II downturn until the Little Depression. Policy changed, because, under Volcker, the Fed took ownership of inflation. It became more rules-based, because, under Volcker, the Fed attempted to follow a modified sort of Monetarist rule, seeking to keep the growth of the monetary aggregates within a pre-determined target range. I have explained in my book and in previous posts (e.g., here and here) why the attempt to follow a Monetarist rule was bound to fail and why the attempt would have perverse feedback effects, but others, notably Charles Goodhart (discoverer of Goodhart’s Law), had identified the problem even before the Fed adopted its misguided policy. The recovery did not begin until the summer of 1982 after the Fed announced that it would allow the monetary aggregates to grow faster than the Fed’s targets.

So the success of the Fed monetary policy under Volcker can properly be attributed to a) to the Fed’s taking ownership of inflation and b) to its decision to abandon the rules-based policy urged on it by Milton Friedman and his Monetarist acolytes like Alan Meltzer whom Taylor now cites approvingly for supporting rules-based policies. The only monetary policy rule that the Fed ever adopted under Volcker having been scrapped prior to the beginning of the recovery from the 1981-82 recession, the notion that the Great Moderation was ushered in by the Fed’s adoption of a “rules-based” policy is a total misrepresentation.

But Taylor is not done.

Few complained about spillovers or beggar-thy-neighbor policies during the Great Moderation.  The developed economies were effectively operating in what I call a nearly international cooperative equilibrium.

Really! Has Professor Taylor, who served as Under Secretary of the Treasury for International Affairs ever heard of the Plaza and the Louvre Accords?

The Plaza Accord or Plaza Agreement was an agreement between the governments of France, West Germany, Japan, the United States, and the United Kingdom, to depreciate the U.S. dollar in relation to the Japanese yen and German Deutsche Mark by intervening in currency markets. The five governments signed the accord on September 22, 1985 at the Plaza Hotel in New York City. (“Plaza Accord” Wikipedia)

The Louvre Accord was an agreement, signed on February 22, 1987 in Paris, that aimed to stabilize the international currency markets and halt the continued decline of the US Dollar caused by the Plaza Accord. The agreement was signed by France, West Germany, Japan, Canada, the United States and the United Kingdom. (“Louvre Accord” Wikipedia)

The chart below shows the fluctuation in the trade weighted value of the US dollar against the other major trading currencies since 1980. Does it look like there was a nearly international cooperative equilibrium in the 1980s?

taylor_dollar_tradeweighted

But then there was a setback. The Fed decided to hold the interest rate very low during 2003-2005, thereby deviating from the rules-based policy that worked well during the Great Moderation.  You do not need policy rules to see the change: With the inflation rate around 2%, the federal funds rate was only 1% in 2003, compared with 5.5% in 1997 when the inflation rate was also about 2%.

Well, in 1997 the expansion was six years old and the unemployment rate was under 5% and falling. In 2003, the expansion was barely under way and unemployment was rising above 6%.

I could provide other dubious historical characterizations that Taylor makes in his talk, but I will just mention a few others relating to the Volcker episode.

Some argue that the historical evidence in favor of rules is simply correlation not causation.  But this ignores the crucial timing of events:  in each case, the changes in policy occurred before the changes in performance, clear evidence for causality.  The decisions taken by Paul Volcker came before the Great Moderation.

Yes, and as I pointed out above, inflation came down when Volcker and the Fed took ownership of the inflation, and were willing to tolerate or inflict sufficient pain on the real economy to convince the public that the Fed was serious about bringing the rate of inflation down to a rate of roughly 4%. But the recovery and the Great Moderation did not begin until the Fed renounced the only rule that it had ever adopted, namely targeting the rate of growth of the monetary aggregates. The Fed, under Volcker, never even adopted an explicit inflation target, much less a specific rule for setting the Federal Funds rate. The Taylor rule was just an ex post rationalization of what the Fed had done by instinct.

Another point relates to the zero bound. Wasn’t that the reason that the central banks had to deviate from rules in recent years? Well it was certainly not a reason in 2003-2005 and it is not a reason now, because the zero bound is not binding. It appears that there was a short period in 2009 when zero was clearly binding. But the zero bound is not a new thing in economics research. Policy rule design research took that into account long ago. The default was to move to a stable money growth regime not to massive asset purchases.

OMG! Is Taylor’s preferred rule at the zero lower bound the stable money growth rule that Volcker tried, but failed, to implement in 1981-82? Is that the lesson that Taylor wants us to learn from the Volcker era?

Some argue that rules based policy for the instruments is not needed if you have goals for the inflation rate or other variables. They say that all you really need for effective policy making is a goal, such as an inflation target and an employment target. The rest of policymaking is doing whatever the policymakers think needs to be done with the policy instruments. You do not need to articulate or describe a strategy, a decision rule, or a contingency plan for the instruments. If you want to hold the interest rate well below the rule-based strategy that worked well during the Great Moderation, as the Fed did in 2003-2005, then it’s ok as long as you can justify it at the moment in terms of the goal.

This approach has been called “constrained discretion” by Ben Bernanke, and it may be constraining discretion in some sense, but it is not inducing or encouraging a rule as a “rules versus discretion” dichotomy might suggest.  Simply having a specific numerical goal or objective is not a rule for the instruments of policy; it is not a strategy; it ends up being all tactics.  I think the evidence shows that relying solely on constrained discretion has not worked for monetary policy.

Taylor wants a rule for the instruments of policy. Well, although Taylor will not admit it, a rule for the instruments of policy is precisely what Volcker tried to implement in 1981-82 when he was trying — and failing — to target the monetary aggregates, thereby driving the economy into a rapidly deepening recession, before escaping from the positive-feedback loop in which he and the economy were trapped by scrapping his monetary growth targets. Since 2009, Taylor has been calling for the Fed to raise the currently targeted instrument, the Fed Funds rate, even though inflation has been below the Fed’s 2% target almost continuously for the past three years. Not only does Taylor want to target the instrument of policy, he wants the instrument target to preempt the policy target. If that is not all tactics and no strategy, I don’t know what is.

The Verbally Challenged John Taylor Strikes Again

John Taylor, tireless self-promoter of “rules-based monetary policy” (whatever that means), inventor of the legendary Taylor Rule, and very likely the next Chairman of the Federal Reserve Board if a Republican is elected President of the United States in 2016, has a history of verbal faux pas, which I have been documenting not very conscientiously for almost three years now.

Just to review my list (for which I make no claim of exhaustiveness), Professor Taylor was awarded the Hayek Prize of the Manhattan Institute in 2012 for his book First Principles: Five Keys to Restoring America’s Prosperity. The winner of the prize (a cash award of $50,000) also delivers a public Hayek Lecture in New York City to a distinguished audience consisting of wealthy and powerful and well-connected New Yorkers, drawn from the city’s financial, business, political, journalistic, and academic elites. The day before delivering his public lecture, Professor Taylor published a teaser as an op-ed in that paragon of journalistic excellence the Wall Street Journal editorial page. (This is what I had to say when it was published.)

In his teaser, Professor Taylor invoked Hayek’s Road to Serfdom and his Constitution of Liberty to explain the importance of the rule of law and its relationship to personal freedom. Certainly Hayek had a great deal to say and a lot of wisdom to impart on the subjects of the rule of law and personal freedom, but Professor Taylor, though the winner of the Hayek Prize, was obviously not interested enough to read Hayek’s chapter on monetary policy in The Constitution of Liberty; if he had he could not possibly have made the following assertions.

Stripped of all technicalities, this means that government in all its actions is bound by rules fixed and announced beforehand—rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one’s individual affairs on the basis of this knowledge. . . .

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 from Taylor’s in The Constitution of Liberty:

[T]he case against discretion in monetary policy is not quite the same as that against discretion in the use of the coercive powers of government. Even if the control of money is in the hands of a monopoly, its exercise does not necessarily involve coercion of private individuals. The argument against discretion in monetary policy rests on the view that monetary policy and its effects should be as predictable as possible. The validity of the argument depends, therefore, 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.

Now that was bad enough – 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. Perhaps it got a bit garbled in the teasing process. So I went to the Manhattan Institute website and watched the video of the entire Hayek Lecture delivered by Professor Taylor. But things got even worse in the lecture – much worse. I mean disastrously worse. (This is what I had to say after watching the video.)

Taylor, while of course praising Hayek at length, simply displayed an appalling ignorance of Hayek’s writings and an inability to comprehend, or a carelessness so egregious that he was unable to properly read, the title — yes, the title! — of a pamphlet written by Hayek in the 1970s, when inflation was reaching the double digits in the US and much of Europe. The pamphlet, entitled Full Employment at any Price?, was an argument that the pursuit of full employment as an absolute goal, with no concern for price stability, would inevitably lead to accelerating inflation. The title was chosen to convey the idea that the pursuit of full employment was not without costs and that a temporary gain in employment at the cost of higher inflation might well not be worth it. Professor Taylor, however, could not even read the title correctly, construing the title as prescriptive, and — astonishingly — presuming that Hayek was advocating the exact policy that the pamphlet was written to confute.

Perhaps Professor Taylor was led to this mind-boggling misinterpretation by a letter from Milton Friedman, cited by Taylor, complaining about Hayek’s criticism in the pamphlet in question of Friedman’s dumb 3-perceent rule, to which criticism Friedman responded in his letter to Hayek. But Professor Taylor, unable to understand what Hayek and Friedman were arguing about, bewilderingly assumed that Friedman was criticizing Hayek’s advocacy of increasing the rate of inflation to whatever level was needed to ensure full employment, culminating in this ridiculous piece of misplaced condescension.

Well, once again, Milton Friedman, his compatriot in his cause — and it’s good to have compatriots by the way, very good to have friends in his cause. He wrote in another letter to Hayek – Hoover Archives – “I hate to see you come out, as you do here, for what I believe to be one of the most fundamental violations of the rule of law that we have, namely, discretionary activities of central bankers.”

So, hopefully, that was enough to get everybody back on track. Actually, this episode – I certainly, obviously, don’t mean to suggest, as some people might, that Hayek changed his message, which, of course, he was consistent on everywhere else.

And all of this wisdom was delivered by Professor Taylor in his Hayek Lecture upon being awarded the Hayek Prize. Well done, Professor Taylor, well done.

Then last July, in another Wall Street Journal op-ed, Professor Taylor replied to Alan Blinder’s criticism of a bill introduced by House Republicans to require the Fed to use the Taylor Rule as its method for determining what its target would be for the Federal Funds rate. The title of the op-ed was “John Taylor’s reply to Alan Blinder,” and the subtitle was “The Fed’s ad hoc departures from rule-based monetary policy has [sic!] hurt the economy.” When I pointed out the grammatical error, and wondered whether the mistake was attributable to Professor Taylor or stellar editorial writers employed by the Wall Street Journal editorial page, David Henderson, a frequent contributor to the Journal, wrote a comment to assure me that it was certainly not Professor Taylor’s mistake. I took Henderson’s word for it. (Just for the record, the mistake is still there, you can look it up.)

But now there’s this. In today’s New York Times, there is an article about how, in an earlier era, criticism of the Fed came mainly from Democrats complaining about money being too tight and interests rates too high, while now criticism comes mainly from Republicans complaining that money is too easy and interest rates too low. At the end of the article we find this statement from Professor Taylor:

Practical experience and empirical studies show that checklist-free medical care is wrought with dangers just as rules-free monetary policy is,” Mr. Taylor wrote in a recent defense of his proposal.

There he goes again. Here are five definitions of “wrought” from the online Merriam-Webster dictionary:

1:  worked into shape by artistry or effort <carefully wrought essays>

2:  elaborately embellished :  ornamented

3:  processed for use :  manufactured <wrought silk>

4:  beaten into shape by tools :  hammered —used of metals

5:  deeply stirred :  excited —often used with up <gets easily wrought up over nothing>

Obviously, what Professor Taylor meant to say is that medical care is “fraught” (rhymes with “wrought”) with dangers, but some people just can’t be bothered with pesky little details like that, any more than winners of the Hayek Prize can be bothered with actually reading the works of Hayek to which they refer in their Hayek Lecture. Let’s just hope that if Professor Taylor’s ambition to become Fed Chairman is realized, he’ll be a little bit more attentive to, say, the position of decimal points than he is to the placement of question marks and to the difference in meaning between words that sound almost alike.

PS I see that the Manhattan Institute has chosen James Grant as the winner of the 2015 Hayek Prize for his book America’s Forgotten Depression. I’m sure that 2015 Hayek Lecture will be far more finely wrought grammatically and stylistically than the 2012 Hayek Lecture, but, judging from book for which the prize was awarded, I am not overly optimistic that it will make a great deal more sense than the 2012 Hayek Lecture, but that is not a very high bar to clear.

Who Is Grammatically Challenged? John Taylor or the Wall Street Journal Editorial Page?

Perhaps I will get around to commenting on John Taylor’s latest contribution to public discourse and economic enlightenment on the incomparable Wall Street Journal editorial page. And then again, perhaps not. We shall see.

In truth, there is really nothing much in the article that he has not already said about 500 times (or is it 500 thousand times?) before about “rule-based monetary policy.” But there was one notable feature about his piece, though I am not sure if it was put in there by him or by some staffer on the legendary editorial page at the Journal. And here it is, first the title followed by a teaser:

John Taylor’s Reply to Alan Blinder

The Fed’s ad hoc departures from rule-based monetary policy has hurt the economy.

Yes, believe it or not, that is exactly what it says: “The Fed’s ad hoc departures from rule-based monetary policy has [sic!] hurt the economy.”

Good grief. This is incompetence squared. The teaser was probably not written by Taylor, but one would think that he would at least read the final version before signing off on it.

UPDATE: David Henderson, an authoritative — and probably not overly biased — source, absolves John Taylor from grammatical malpractice, thereby shifting all blame to the Wall Street Journal editorial page.

John Taylor, Post-Modern Monetary Theorist

In the beginning, there was Keynesian economics; then came Post-Keynesian economics.  After Post-Keynesian economics, came Modern Monetary Theory.  And now it seems, John Taylor has discovered Post-Modern Monetary Theory.

What, you may be asking yourself, is Post-Modern Monetary Theory all about? Great question!  In a recent post, Scott Sumner tried to deconstruct Taylor’s position, and found himself unable to determine just what it is that Taylor wants in the way of monetary policy.  How post-modern can you get?

Taylor is annoyed that the Fed is keeping interest rates too low by a policy of forward guidance, i.e., promising to keep short-term interest rates close to zero for an extended period while buying Treasuries to support that policy.

And yet—unlike its actions taken during the panic—the Fed’s policies have been accompanied by disappointing outcomes. While the Fed points to external causes, it ignores the possibility that its own policy has been a factor.

At this point, the alert reader is surely anticipating an explanation of why forward guidance aimed at reducing the entire term structure of interest rates, thereby increasing aggregate demand, has failed to do so, notwithstanding the teachings of both Keynesian and non-Keynesian monetary theory.  Here is Taylor’s answer:

At the very least, the policy creates a great deal of uncertainty. People recognize that the Fed will eventually have to reverse course. When the economy begins to heat up, the Fed will have to sell the assets it has been purchasing to prevent inflation.

Taylor seems to be suggesting that, despite low interest rates, the public is not willing to spend because of increased uncertainty.  But why wasn’t the public spending more in the first place, before all that nasty forward guidance?  Could it possibly have had something to do with business pessimism about demand and household pessimism about employment?  If the problem stems from an underlying state of pessimistic expectations about the future, the question arises whether Taylor considers such pessimism to be an element of, or related to, uncertainty?

I don’t know the answer, but Taylor posits that the public is assuming that the Fed’s policy will have to be reversed at some point. Why? Because the economy will “heat up.” As an economic term, the verb “to heat up” is pretty vague, but it seems to connote, at the very least, increased spending and employment. Which raises a further question: given a state of pessimistic expectations about future demand and employment, does a policy that, by assumption, increases the likelihood of additional spending and employment create uncertainty or diminish it?

It turns out that Taylor has other arguments for the ineffectiveness of forward guidance.  We can safely ignore his two throw-away arguments about on-again off-again asset purchases, and the tendency of other central banks to follow Fed policy.  A more interesting reason is provided when Taylor compares Fed policy to a regulatory price ceiling.

[I]f investors are told by the Fed that the short-term rate is going to be close to zero in the future, then they will bid down the yield on the long-term bond. The forward guidance keeps the long-term rate low and tends to prevent it from rising. Effectively the Fed is imposing an interest-rate ceiling on the longer-term market by saying it will keep the short rate unusually low.

The perverse effect comes when this ceiling is below what would be the equilibrium between borrowers and lenders who normally participate in that market. While borrowers might like a near-zero rate, there is little incentive for lenders to extend credit at that rate.

This is much like the effect of a price ceiling in a rental market where landlords reduce the supply of rental housing. Here lenders supply less credit at the lower rate. The decline in credit availability reduces aggregate demand, which tends to increase unemployment, a classic unintended consequence of the policy.

When economists talk about a price ceiling what they usually mean is that there is some legal prohibition on transactions between willing parties at a price above a specified legal maximum price.  If the prohibition is enforced, as are, for example, rent ceilings in New York City, some people trying to rent apartments will be unable to do so, even though they are willing to pay as much, or more, than others are paying for comparable apartments.  The only rates that the Fed is targeting, directly or indirectly, are those on US Treasuries at various maturities.  All other interest rates in the economy are what they are because, given the overall state of expectations, transactors are voluntarily agreeing to the terms reflected in those rates.  For any given class of financial instruments, everyone willing to purchase or sell those instruments at the going rate is able to do so.  For Professor Taylor to analogize this state of affairs to a price ceiling is not only novel, it  is thoroughly post-modern.


About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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