A Reply to John Taylor

John Taylor responded to my post criticizing his op-ed piece in yesterday’s Wall Street Journal.  Here are some comments on Professor Taylor’s response.

Professor Taylor responds to my charge of exaggerating the difference between U.S. policies “in the years after World War II . . . promoting economic growth through reliance on the market and the incentives it provides” and current supposedly interventionist fiscal and monetary policies and increasingly burdensome regulation by admitting that post-war “American economic policy was not perfect.”  Nevertheless, in the aftermath of World War II, when America helped Japan and Europe recover, “the American model was a far cry from what was being set up in large areas of the world which were not free either economically or politically.” 

Well, yes, but it is somewhat chauvinistic on Professor Taylor’s part to assume that the only intellectual and policy resources on which Europe and Japan could draw were to be found in America.  Economic and political liberalism were imported and adopted, perhaps even improved, by America from Europe, not vice versa.  It is an old story, but perhaps worth repeating for Professor Taylor’s benefit, that in 1948, with the German economy in a state of semi-collapse owing to runaway inflation, price controls, and rationing imposed by the occupying powers, Ludwig Erhard, the German economics minister in the British and American occupation zones, unilaterally lifted price controls and ended rationing while imposing a tight monetary policy, despite the objections of the Allied authorities.   Thus began what would become known as the “German economic miracle” of which Erhard was the acknowledged architect.

Professor Taylor was also a bit shaky in describing what happened in the 1980s and 1990s, calling American economic ideas “contagious, not just in Britain under Margaret Thatcher but in the developing world.”  But Mrs. Thatcher came to power in May 1979, over a year and a half before Ronald Reagan.  So, once again, the flow of ideas went from east to west.

Turning to my charge of inconsistency in opposing quantitative easing by the Fed in 2009 and 2010, when he had supported a similar policy for Japan in 2002, Professor Taylor maintains that since there was actual deflation in Japan (measured by both the CPI and the GDP price deflator) while inflation in the U.S., with only brief exceptions, remained positive after the 2008 financial crisis.  But Professor Taylor himself acknowledged in one of the papers cited in his response to my post that even positive inflation is potentially dangerous when it approaches zero (especially at the zero-interest lower bound) . 

In addition, “increasing the monetary base in Japan” was supposed to “get the growth rate of the money supply . . . back up . . . not to drive up temporarily the price of mortgage securities or stock prices, which is frequently used to justify quantitative easing by the Fed today.”  Ahem, the purpose of getting the growth of the money supply back up in Japan was to stop deflation, thereby increasing output and employment.  Increasing the money supply is just a means to accomplish that objective.  The purpose of quantitative easing in the US is to increase the rate of nominal GDP (NGDP) growth, and thereby increase output and employment.  That some people believe doing so would also have the beneficial side-effect of raising the prices of mortgage securities or stocks is just a red herring.

Professor Taylor also refers to the debate over rules versus discretion in the conduct of monetary policy. 

If a central bank follows a money growth rule of the type Milton Friedman argued for – and which is quite appropriate when the interest rate hit zero in Japan – then the central bank should increase the monetary base to prevent money growth from falling or to increase money growth if it has already fallen.  In other words such an easing policy can be justified as being consistent with a policy rule, in this case for the growth of the money supply.  The rule calls for keeping money growth from declining.  But the large-scale asset purchases by the Fed today are highly discretionary, largely unpredictable, short-term interventions, which are not rule-like at all.  It is the deviation from more predictable rule-like policy by the Fed (which began in 2003-2005 and continues today) that most concerns me.

A Friedman-type rule for growth of the money supply has long since been abandoned even by Friedman, the so-called Taylor rule being an attempt to provide an alternative with which to replace the Friedman rule.  But the Fed, since its unsuccessful attempt to adhere to a Friedman-type rule in 1981-82, has never articulated a specific rule, so it is not clear what rule Professor Taylor believes the Fed has been deviating from since 2003-05.  One could as easily infer from the data that the Fed was following a rule targeting a 5-6% growth path for NGDP as any other rule.  If so, one could argue that quantitative easing designed to restore NGDP growth to its 5-6% long-run trend is as good a rule as any.  Indeed, with inflation expectations (as measured by the TIPS spread) now running well under 2%, and with a substantial output gap, most versions of the Taylor rule would imply that monetary policy should be eased.  If the target interest rate is already at the lower bound, then the alternative is to increase the monetary base.  That’s called quantitative easing. 

Finally, Professor Taylor refers to my “long rebuttal” to his criticism of “recent interventionist fiscal and monetary policies in the United States.”  Inasmuch as nearly half of my post consisted of direct quotations from Professor Taylor, I am afraid that he has an equal share in the blame for the length of my rebuttal.

HT:  Scott Sumner, Lars Christensen, Nick Rowe

13 Responses to “A Reply to John Taylor”

  1. 1 Marcus Nunes November 2, 2011 at 2:39 pm

    A nice and courteous “smackdpwn”. As I implied in my previous comment, Taylor is obsessed with his namesake rule. To him it´s the “holy grail”. And it was the wrong headed MP of 2002-04 that has turned it useless in the present time. So he´s really lost, grabing at straws.


  2. 2 David Pearson November 2, 2011 at 4:10 pm

    “…inflation is potentially dangerous when it approaches zero…”

    Is it approaching zero? 12 month inflation is around 3.6% here, 3% in the EU, and 3.5% in the UK. It is also much higher in emerging markets, and potentially accelerating in China (given wage increases). Meanwhile, our 5yr TIPS spread is back to a normal 2% after much was made of it falling to 1.7% during the summer. Commodity prices are climbing, and the oil price is 40%+ higher than pre-Jackson Hole despite the recent global RGDP growth deceleration.

    One of the reasons why inflation approaching zero is dangerous is because it risks creating positive real interest rates at a time when the economy requires lower ones. Real rates today are negative up to 10yrs. I’m not sure we have ever had the real yield curve submerged below zero like this. Japan’s real yield curve has been consistently positive for the past ten years.

    Is this situation really analogous to Japan’s?


  3. 3 Benjamin Cole November 2, 2011 at 4:22 pm

    John Taylor is a terrific economist, but deeply, deeply partisan. He has written that 1970s inflation was due to 1960s social welfare programs, totally leaving out the Vietnam War!

    He also noted that Carter (who appointed Volcker) wanted Volcker out of the Fed job, while never mentioning that Reaganauts publicly assailed Volcker for his tight-money policies and did edge him out.

    Taylor would rewrite any passage of US economic history to fit the current need of getting rid of Obama.

    David Pearson: Look at core inflation rates going back three years. Also, remember, the CPI overstates inflation. We are in historically low inflation, and possibly deflation.

    Also, do not conflate commodities inflation, now caused by global demand, with US monetary policy. The Chinese and Indians are both pursuing aggressive and expansionist monetary policies (that seem to be working btw).


  4. 4 Will November 2, 2011 at 4:56 pm

    “Inasmuch as nearly half of my post consisted of direct quotations from Professor Taylor, I am afraid that he has an equal share in the blame for the length of my rebuttal.”

    Damn, you have the subtle-but-lethal ending jabs *down*.

    Beyond what you said, doesn’t it seem like if the standard we’re using to judge post-war policy is “was it Soviet central planning?”, we should use the same standard with regard to present policy?


  5. 5 David Glasner November 2, 2011 at 6:55 pm

    Marcus, Thanks for the kind words. No point in being nasty, though sometimes, one can’t help oneself.

    David, In my view, the real rate of interest is probably between 0 and -2% over a two year time horizon which is where expected inflation is. So, we need to get expected inflation up at least another percent or two to get a nominal interest rate up to 2%. Once we get inflation up that high, the real interest rate would quickly start to rise as well, and then everything would turn out nicely.

    Benjamin, I am obviously not happy with Taylor, but I don’t have any knowledge of what he is really all about. My own policy is to take everyone at his word and just criticize based on facts and logic without getting into motivations and ulterior motives. That was Hayek’s approach and I always admired him for it.

    Will, Thanks so much for your comment.


  6. 6 ECON November 3, 2011 at 11:51 am

    The minimum we expect in advice from a “professional” economist is not his subjective musings but his objective advice untainted by political concerns.


  7. 7 MG November 3, 2011 at 12:10 pm

    “My own policy is to take everyone at his word and just criticize based on facts and logic without getting into motivations and ulterior motives.”

    Without understanding, or at least thinking you understand, the motives of people, it becomes impossible to predict their future behavior. And that is a vital component of policy making. Also, as ugly as it is, you give up huge opportunities for suasion. In this world, you are either willing, at least sometimes, to get down in the mud with the hogs, or you get splattered by the mud they throw. Either way, you get muddy.


  8. 8 Benjamin Cole November 3, 2011 at 1:20 pm

    “PRODUCTIVITY UP: Worker productivity rose in the July-September quarter by the most in a year and a half, the Labor Department said. At the same time, labor costs fell.’

    The Chicken Inflation Littles wail about inflation…but labor costs are going down? How does that play out as runaway inflation?


  9. 9 David Glasner November 5, 2011 at 5:59 pm

    MG, You may be right, and there are no absolute rules in these matters, but my inclination is to follow Hayek.


  10. 10 David Glasner November 5, 2011 at 6:03 pm

    Econ, That’s actually a pretty high standard. I’m not sure how many live up to it.

    Benjamin, Where did that come from. I also saw the the employment cost index was up by just 1.4% in the 3rd quarter. So nominal wages have increased by under 2 percent for about 7 out of the last 8 quarter and the one quarter that was more than 2% was 2.1% in the second quarter.


  1. 1 Economist's View: links for 2011-11-03 Trackback on November 3, 2011 at 12:08 am
  2. 2 Link roundup « Negative Interest Trackback on November 3, 2011 at 4:11 pm
  3. 3 Policy Rules Are Not Rules, They Are Policies « Uneasy Money Trackback on December 6, 2011 at 2:55 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. 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.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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