Is the Taylor Rule in jeopardy?
Simply put, it is the monetary policy targeting rule that aims to keep inflation tethered as closely as possible to 2% as it can over time. And maybe over simplifying, with apologies to John Taylor who is the father of the rule named for him, here’s how it works: when the economy grows faster, and inflation rises above its 2% target, it opens the door to Federal Reserve rate hikes; if the economy slows down, unemployment starts rising, it opens the other door, the one toward rate cuts. The Taylor Rule also has a prescription for how fast the Fed react to get inflation back into target when it has deviated. Over the thirty-plus years since professor Taylor developed this rule, it has become a tool for Fed policy makers, and central bankers around the world. In practice, it has become more of a guidepost for monetary policy makers rather than a precise rule, one that has helped keep prices stable and prevent inflation from getting out of control in many economies.
So why is Ken Rogoff saying that this rule which spans four decades of helping to keep inflation under control may be in danger? Rogoff is a highly respected professor of economics and public policy at Harvard University, and co-author of the influential book “This Time is Different: Eight Centuries of Financial Folly,” which analyses how and why countries have been lending, borrowing, crashing, and recovering their way through an extraordinary range of financial crises. Clearly historical context is right up his alley.
In a piece written for Project Syndicate, Rogoff argues that the Taylor Rule approach, which worked well for the 40 years starting from when former Fed Chair Paul Volcker used a broad version of this strategy to bring down double-digit inflation, is going to be attacked. He says that during those years there were a variety of disinflationary winds at the back of central bankers which are dissipating. Rate hikes to keep inflation low will face resistance from government officials who need to finance deficits. Central bank independence will be under fire.
The intro to his piece says, “While rules-based monetary policy (my emphasis) thrived when globalization put downward pressure on inflation, the COVID-19 pandemic has revived central bankers’ long-dormant preference for inflationary policies. This shift may help central banks maintain their independence, but it also increases the likelihood of another surge of price growth.”
So when I saw this I immediately called John Taylor himself. By way of more formal introduction, John is John B. Taylor is the George P. Shultz Senior Fellow in Economics at the Hoover Institution and the Mary and Robert Raymond Professor of Economics at Stanford University.
Taylor served as senior economist on President Ford's and President Carter’s Council of Economic Advisers, as a member of President George H. W. Bush's Council of Economic Advisers, and as a senior economic adviser to Bob Dole’s presidential campaign, to George W. Bush’s presidential campaign in 2000, and to John McCain’s presidential campaign. He was a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001. From 2001 to 2005, Taylor served as undersecretary of the Treasury for international affairs where he was responsible for currency markets, international development, for oversight of the International Monetary Fund and the World Bank, and for coordinating policy with the G-7 and G-20.
Without further ado, here’s why John believes the viability and durability of his rule is intact. And also why he is on board with the Fed taking its time to to let inflation continue to decline as he also thinks it will. And why he says the Fed will endorse his current 4% estimate of the Taylor Rule at next week’s meeting.
John Taylor: Rule Will Support Central Banks in Face of Political Pressure