Monetary policy guru John Taylor presented his eponymous rule to the world in article he published in 1993 where he proposed, a simple idea to guide monetary policy in his article, "Discretion Versus Policy Rules in Practice.“ The rest is history.
As the Stanford Economic for Policy Research puts it, “Quickly the idea spread, not only through academia, but also to the trading floors of Wall Street and the Federal Reserve's boardroom in Washington. Now, two decades later, the Taylor rule remains a focal point for discussions of monetary policy around the world.”
Professor Taylor sat down with me at the Hoover Institution on as the Shadow Open Market Committee celebrated its 50-year anniversary, and the role he has played in promoting a rules-based approach to monetary policy to augment the discretion-based approach that prevailed for many years.
”The idea of the Taylor Rule is to find a way that it could map the Fed's decisions, which was about the federal funds rate, into the actual decisions they make,” he says. “And it's based on a simple formula to look at deflation, look at the GDP gap, as simple as it could possibly be. And it has worked pretty well for a long time.”
Taylor continues to see his rule pointing to the Fed cutting its key policy rate as low as 4%. “Remember (rates) were very low and they got up … maybe a little bit too high, but they should get to a rate which is get to rate which is the equilibrium rate, or the rate where they should be and that’s a little bit lower. That’s why I say for 4%.”
As for what needs to happen next in the evolution of his rule? Taylor wants it go more global and take into account that his rule just not only depend what is happening in the U.S. It’s also about what central bankers are doing in Europe, Japan, and the rest of the world.
”It’s a global system and that’s why I think the so-called Taylor Rule, or whatever you want to call it has to be applied more generally,” he says. Other central banks are looking at their key policy rate and gauging if it’s too high versus the Fed’s.
”So I think the thing is that what I would hope for eventually is there will not a global agreement… but a global situation where the global statement about what the inflation rate should be and that the interest rate should be.”
Hear and see more about how fast the Fed gets inflation down to its 2% target, why Fed communication on this issue is so important, and a whole lot more.
John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the George P. Shultz Senior Fellow in Economics at the Hoover Institution. He is Director of the Stanford Introductory Economics Center. He formerly served as director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow.
Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world.
He served as senior economist on the President’s Council of Economic Advisers from 1976 to 1977, as a member of the President’s Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office’s Panel of Economic Advisers from 1995 to 2001.
For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the OECD working party on international macroeconomics, and was a Member of the Board of the Overseas Private Investment Corporation.
thatAnd he expects it to move gradually toward that goal as Fed governor Chris Waller suggested it would as he spoke earlier that day as he spoke at the SOMC event.
Federal Reserve should raise the interest rate when inflation increases and lower the interest rate when gross domestic product (GDP) declines. The desired interest rate is one-and-a-half times the inflation rate, plus one-half times the gap between GDP and its potential, plus one.
SIEPR Put simply, the Taylor rule says that the Federal Reserve should raise the interest rate when inflation increases and lower the interest rate when gross domestic product (GDP) declines. The desired interest rate is one-and-a-half times the inflation rate, plus one-half times the gap between GDP and its potential, plus one.
John Taylor Rules! Acclaimed Economist Seeks to Globalize His Rule