John Taylor Misunderstands Hayek

In an op-ed piece in today’s Wall Street Journal, John Taylor, seeking to provide some philosophical heft for his shallow arguments for “rules-based fiscal, monetary, and regulatory policies” and his implausible claim that “unpredictable economic policy . . . is the main cause of persistent high unemployment and our feeble recovery from the recession,” invokes the considerable authority of F. A. Hayek. Taylor’s op-ed, based on his Hayek Prize Lecture to the Manhattan Institute on the occasion of receiving the Institute’s Hayek Prize for his new book First Principles: Five Keys to Restoring America’s Prosperity, shows little sign of careful reading of or serious thought about what Hayek had to say on the subject of rules.

Perhaps I shouldn’t take it too personally, but I can’t help but observe that just about six months ago, I wrote a post entitled “John Taylor’s Obsession with Rules” in which I quoted liberally from Hayek’s writings on monetary policy, especially from Hayek’s Constitution of Liberty. My earlier post was prompted by a critique of NGDP targeting that Taylor posted on his blog in which he compared NGDP targeting unfavorably with Milton Friedman’s 3-per cent rule for growth in the money supply. Taylor criticized NGDP targeting, because, unlike the Friedman rule, it allowed the Fed to exercise discretion in achieving its target, evidently not grasping the obvious fact that the Fed has no more control over M2 than it does over NGDP.

I cited Hayek’s views about monetary policy to make two basic points: 1) inasmuch as monetary authorities exercise no coercive power over individuals, the liberal principle that government action be undertaken only in strict conformity with known rules of general applicability does not apply to central banks, and 2) the nature of monetary policy unavoidably requires a central bank to employ some discretion in discharging its duties. Thus, the strict Friedmanian 3-percent rule, considered by Taylor to be the epitome of rules-based monetary policy, had no basis either in Hayek’s understanding of liberalism or in his understanding of the requirements of monetary policy. Indeed, Hayek on a number of occasions explicitly repudiated the 3-percent rule. After quoting several passages from Hayek explaining these points, I concluded with the following advice: “Professor Taylor, forget Friedman, and study Hayek.”

Well, I’m not sure what to make of Taylor’s invocation of Hayek in his op-ed. I guess if you are awarded the Hayek Prize, it’s only fitting to say something nice about the old sage, and at least feign some interest in what he had to say. But if Taylor did made a substantial investment in studying what Hayek wrote about following rules in the conduct of monetary policy, I see no evidence of it in his op-ed.

Let’s compare what Taylor with what Hayek said. Here’s Taylor:

Hayek argued that the case for rules-based policy goes beyond economics and should appeal to all those concerned about assaults on freedom. He wrote in his classic 1944 book, “The Road to Serfdom,” that “nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles known as the Rule of Law.”

Hayek added, “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.”

Now Hayek (from Chapter 21 of 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. (p. 334)

Taylor also mentions the point that a rules-based monetary policy enhances the predictability of monetary policy, which presumably results in increased predictability of the economic environment in which economic agents make their decisions.

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 in Chapter 21 of the CoL, Hayek went on to explain why a central bank could not effectively conduct policy by mechanically applying rules in a fully predictable fashion. (This conclusion might have to be revised if the monetary regime had a mechanism for targeting the expectations, but that possibility raises too many complicated issues to pursue here.) Back to Hayek:

There is one basic dilemma, which all central banks face, which makes it inevitable that their policy must involve much discretion. A central bank can exercise only an indirect and therefore limited control over all the circulating media. Its power is based chiefly on the threat of not supplying cash when it is needed. Yet at the same time it is considered to be its duty never to refuse to supply this case at a price when needed. It is this problem, rather than the general effects of policy on prices or the value of money, that necessarily preoccupies the central banker in his day-to-day actions. It is a task which makes it necessary for the central bank constantly to forestall or counteract development in the realm of credit, for which no simple rules can provide sufficient guidance.

The same is nearly as true of the measures intended to affect prices and employment. They must be directed more at forestalling changes before they occur than at correcting them after they have occurred. If a central bank always waited until rule or mechanism forced it to take action, the resulting fluctuations would be much greater than they need be. . . .

[U]nder present conditions we have little choice but to limit monetary policy by prescribing its goals rather than its specific actions. The concrete issue today is whether it ought to keep stable some level of employment or some level of prices. Reasonably interpreted and with due allowance made for the inevitability of minor fluctuations around a given level, these two aims are not necessarily in conflict, provided that the requirements for monetary stability are given first place and the rest of economic policy is adapted to them. A conflict arises, however, if “full employment” is made the chief objective and this is interpreted, as it sometimes is, as that maximum of employment which can be produced by monetary means in the short run. That way lies progressive inflation. (pp. 336-37)

So my advice of six months ago, “Professor Taylor, forget Friedman, and study Hayek” is still good advice.  I hope, but am not confident, that Professor Taylor will follow it.


17 Responses to “John Taylor Misunderstands Hayek”

  1. 1 Mike Sproul June 1, 2012 at 1:41 pm

    I know of only one rule that a bank really has to follow: Only issue money to those who offer adequate collateral and pay an adequate interest rate.

    Of course, nobody has to tell bankers to do that, least of all economists and monopolistic central bankers. They do it on their own, or risk insolvency. And as long as banks operate this way, they will be led, as if by an invisible hand, to provide us with the efficient quantity and quality of money.


  2. 2 dwb June 1, 2012 at 4:27 pm

    Taylor is running for a position in the Romney administration and needs to genuflect at the alter of Hayek for the right wing boys in the GOP. Why would we take anything he says in any other spirit than the quackery that is intended?


  3. 3 g2-dcc29df00acec64526eaf79ab9d19b3e June 1, 2012 at 8:25 pm

    Mr. Glasner, I had written a bigger reply about Mr. Taylor op-ed but i was not logged in and therefore it got lost, anyway I wanted to thank you to mention the delivered misused of Hayek’s work by Mr. Taylor to justify central intervention limited by some fix rule (that mysteriously he developed, I smell a little pretence of knowledge there).

    I also wanted to invite you to check my blog about spontaneous order, monetary policies and some little austrian flare.

    Pablo Paniagua


  4. 4 Tas von Gleichen June 2, 2012 at 4:10 am

    If he didn’t do it back than, I have little hope that Mr. Taylor will do it now. At least he is not following someone that thinks in Keynesian Theology.


  5. 5 Frank Restly June 3, 2012 at 5:37 pm

    “In an op-ed piece in today’s Wall Street Journal, John Taylor, seeking to provide some philosophical heft for his shallow arguments..”

    If economists must rely on the soft sciences (philosophy, sociology, psychology) to make economic arguments, then the field of economics is truly lost.


  6. 6 Greg Ransom June 3, 2012 at 8:34 pm

    You point about “monetary rules” is a good one, but it doesn’t begin to address the “rules” issue when it come the the U.S. Fed and its behavior over the last half decade.

    I can’t imagine that Hayek anticipated that a Central Bank would conduct its function via the massive arbitrary interventions into private equity markets, buying up some toxic assets & not others, helping save some firms and not others, and participating in the rule of law violating Gm/GMAC bailout, etc.

    As Gerald O’Driscoll, Jr. and Lawrence White describe Fed activities over the last half decade, the Fed has participated and supported all sorts of massive arbitrary & usually secret interventions with neither democratic nor market oversight, and little or no controlling legal authority.


  7. 7 David Glasner June 4, 2012 at 9:56 am

    Mike, Well, that’s a good place to start, but it does sometimes get more complicated than that, don’t you think?

    dwb, I have no problem with Taylor’s running for whatever position he wants to, but if he is going to talk about Hayek and invoke his authority, let him at least both to get his basic facts straight, which he obviously hasn’t, especially when delivering the Hayek Prize lecture. But, on second thought, maybe you are right; maybe I am setting the bar too high.

    Pablo, Thanks, but it seems to me that your criticism of Taylor does not exactly match up with my own.

    Tas, You are right, I am not going to get my hopes up for Professor Taylor.

    Frank, You can never tell where you may find a valuable insight. After all, Democritus proposed the existence of individual atoms about 2400 years ago.

    Greg, Fair enough. I accept that not all actions of the Fed does can be condoned on Hayekian principles. Having said that, I would just add, speaking for myself only, and not trying to represent Hayek’s views, that some of the actions that O’Driscoll and White are criticizing might be defensible as emergency measures taken to avoid a financial meltdown. But I am not saying that they are defensible, only that they might be.


  8. 8 Mike Sproul June 4, 2012 at 10:42 am

    David: More complicated? The worst complication I can think of is widespread bank runs (on either private or central banks, or both). Adequate backing is, of course, the first line of defense against bank runs, and adequate backing is exactly what that backing rule gives us. If, in spite of following the backing rule, the bank somehow becomes insolvent anyway, then the next steps are either (1) suspend convertibility, letting the the value of the bank’s money drop to maybe 90% of its old value, or (2) liquidate the bank, paying money-holders 90% of the previous value of their money. After either step, the economy will be short of cash, but that’s easily fixed. People who need 10% more money to conduct their business will eagerly bring assets down to their bank and ask for new money in exchange. All the bank then has to do is issue more money in exchange for adequate backing.

    If there is some superior, practical alternative to the backing rule (like, for example, robbing taxpayers to bail out insolvent banks?), then I haven’t heard of it.


  9. 9 Greg Ransom June 4, 2012 at 1:20 pm

    This is a potential problem for pre-1970s Hayek — if there is no way to distinguish the arbitrary picking of favoured winners and losers from arbitrary measures to stablize the money supply, you have no genuine boundry between lawless commandeering of the commanding heights of the economy for whatever purpose from simple Bagehot rules money supply maintenance.


  10. 10 Frank Restly June 4, 2012 at 2:00 pm

    “You can never tell where you may find a valuable insight. After all, Democritus proposed the existence of individual atoms about 2400 years ago.”

    And you found insight in Taylor’s use of philosophy to defend what should be a straightforward argument about economic policy?

    Democritus proposed the existence of individual atoms to try to explain phenomenon that was directly observable to him (for example erosion). Yes he was a philosopher, yes he did not use any “scientific methodology” to arrive at this conclusions (other than his own naked observations), but that did not prevent him from reaching the reasonable conclusion that large objects (oceans, rocks, etc.) are made up of teenie, tiny bits of homogenous material (atoms).

    My point is not that philosophers are bad at economics. My point is that taking a philosophical / moralistic right versus wrong approach to economic policy is like two kids sitting in a sand box yelling he hit me first. If that is what economics has devolved into, then it is truly a lost profession.

    Mr. Taylor (like any good applied scientist) could have listed his economic objectives and he then could have described in precise detail how both monetary (interest rate) and fiscal (tax and spending) are applied to reach those objectives. He could then have pulled oodles of data from a number of sources (St. Louis federal reserve for instance) to provide backing for his economic approach.


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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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