John Taylor has had a long and distinguished career both as an academic economist and as a government official and policy-maker. He is justly admired for his contributions as an economist and well-liked by his colleagues and peers as a human being. So it gives me no pleasure to aim criticism in his direction. But it was pretty disturbing to read Professor Taylor’s op-ed piece (“A Slow-Growth America Can’t Lead the World”) in today’s Wall Street Journal, a piece devoid of even the slightest attempt to make a reasoned argument rather than assemble a hodge podge of superficial bromides about the magic of the market and the importance of fiscal discipline and sound monetary policies. It is almost surprising that Taylor failed to mention motherhood, apple pie, and American flag while he was at. Even more disturbing, Taylor proceeds, with no hint of embarrassment, to trash the half-hearted attempts by the Federal Reserve to use monetary policy to promote recovery even though the Fed’s policies are similar to, though much less aggressive than, the “quantitative easing” that he applauded the Japanese government and the Bank of Japan for adopting from 2002 to 2004 to extricate Japan from a decade-long period of deflation and slow growth starting in the early 1990s.
Taylor begins by attacking President Obama’s policies, strongly suggesting that those policies are responsible for the weak economic recovery.
At the most recent [G-20] meeting a year ago in Seoul, the G-20 rejected [President Obama’s] pleas for a deficit-increasing Keynesian stimulus and instead urged credible budget-deficit reduction and a return to sound fiscal policy. And on that trip he had to defend the activist monetary policy of the Federal Reserve against widespread criticism that its easy money was damaging to emerging-market countries, causing volatile capital flows and inflationary pressures.
With a weak recovery – retarded by new health-care legislation and financial regulations, an exploding debt, and threats of higher taxes – the U.S. is in no position to lead as it has in the past.
Taylor then invidiously compares Obama’s failure in Seoul with the good old days after World War II when America called the shots.
By contrast, in the years after World War II, the U.S. led the world in promoting economic growth through reliance on the market and the incentives it provides, the rule of law, limited government, and more predictable fiscal and monetary policy.
This tendentious characterization of post-war economic policy overlooks the many sectors of the US economy then subject to strict regulation of prices and other aspects of their business operations, the powerful position of labor unions, and top marginal income tax rates as high as 92%, falling to 70% only after the Kennedy tax cuts were enacted in 1964. High marginal tax rates and powerful labor unions were the norm in all developed countries in the 1950s and 1960s, so economic reality was far from the free-market utopia one might have imagined based on the comic-book picture offered by Taylor. But that comic-book picture inspires Taylor to draw the following grand geopolitical lesson from the history of the last 65 years.
As the U.S. has moved away from the principles of economic freedom – instead promoting short-term fiscal and monetary interventionism with more federal government regulations – its leadership has declined. Some, even in the U.S., may cheer the decline, but it is not good for the world or the U.S.
Warming to his area of special expertise, monetary policy, Taylor continues by expounding on the evils of “monetary interventionism”
In the case of monetary policy . . . decisions on interest rates by foreign central banks are influenced by interest-rate decisions at the Federal Reserve because of the large size of the U.S. economy. If the Fed holds its interest rate too low for too long, then central banks in other countries will have to hold rates low too, creating inflation risks. If they resist, capital flows into their countries seeking higher seeking higher yields, thereby jacking up the value of their currencies and the prices of their exports.
But Professor Taylor has not always taken such a negative view of “monetary interventionism.” In 2006, he wrote a background paper for the International Conference of the Economic and Social Research Institute Cabinet Office of the Government of Japan (September 14, 2006) entitled (I swear) “Lessons from the Recovery from the “Lost Decade” in Japan: The Case of the Great Intervention and Money Injection.”
Describing his involvement in 2001, while Under-Secretary of the Treasury for International Affairs in the Bush Administration, in the formulation and execution of Japanese monetary policy, Taylor writes:
[I]n March 2001, the Bank of Japan announced that it would follow the new type of monetary policy, which it called “quantitative easing” and under which it would pump up the money supply in Japan until deflation ended. I was ecstatic when I heard this announcement. Since 1994 I had been an adviser to the Bank of Japan, a position I had to resign from when I joined the Bush Administration and I had recommended many times that the Bank of Japan focus on increasing the money supply as a means to end their deflation, and many other economists had recommended the same thing.
Now it’s true that inflation in the US as measured by the CPI has been running in the 3-4% range over the past year, but average inflation over the past 3 years has averaged only about 1% and expected inflation over a two-year time horizon has been consistently below 2% for the last year. So the recent rise in inflation seems to be a transitory phenomenon while GDP growth remains very slow and unemployment very high. With inflation, after a short blip, again falling and expected to remain very low for years, it is not at all clear that our situation is much different from the situation in Japan in 2001. Yet Taylor wrote in 2006 that he had been ecstatic when he heard that the Bank of Japan “would pump up the money supply in Japan until deflation ended,” while now protesting his unqualified opposition to a not entirely dissimilar, though certainly less aggressive, policy by the Federal Reserve.
Taylor goes on to describe how the Japanese exited from their “monetary intervention.”
During the fall and winter evidence of a sustainable recovery in Japan mounted, and I thought that the sooner the recovery became clear, the soon Japan could exit from its intervention. On December 5, 2003, I gave a speech in New York asserting that Japan was on the road to recovery. It was still a little risky to declare victory that early, but fortunately I was right and the economy had indeed turned the corner. Michael Phillips of the Wall Street Journal wrote a piece entitled “U.S. Sees Reason to be Optimistic on Japan Growth” on the morning of my talk saying: “The Bush Administration believes the Japanese economy may finally have turned the corner after more than a decade of little or no growth. In a speech to be delivered today, the Treasury Department’s top international official, John Taylor, will credit the Koizumi government’s market changes and the Bank of Japan’s accommodating monetary policy for giving impetus to the country’s laggard economy. . . The upbeat comments from the Undersecretary of the Treasury for International Affairs represent a sharp shift in Washington’s long pessimistic view of Japan’s fortunes.”
In today’s Journal, however, the possibility that “monetary intervention” could give “impetus the [U.S]’s lagging economy” seems never even to have crossed Professor Taylor’s mind.
Some countries . . . are complaining that the Fed is exporting inflation with its near-zero interest rate and massive purchases of long-term government debt. . . And when global inflation picks up, as it has started to do in many emerging markets, it feeds back into more inflation in the U.S. through higher prices of globally traded commodities. With unemployment already high, the result would be stagflation – slow growth, high inflation, steady unemployment – as we saw in the 1970s.
I guess we are just supposed to forget, along with Professor Taylor, about “accommodating monetary policy giving impetus to the country’s laggard economy.” Oh my what a difference four or five years make. Things do change, don’t they?
HT: Benjamin Cole