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.