Writing in Thursday’s Wall Street Journal, John Taylor takes the Federal Reserve to task for its “interventionist” behavior.
Taylor’s main complaint with the Fed’s conduct of monetary policy is that it is unstable and unpredictable (verging on the whimsical!). He argues that this stems in part from the Fed’s mandate to pursue low unemployment in addition to price stability. He further argues that a more predictable “rules-based” monetary policy, focused solely on maintaining price stability, would be more appropriate.
The problem with Taylor’s argument is that his definition of “rules based policy” is too vague to be useful.
The epitome of a rules based monetary policy is the gold standard: if monetary policy is dictated by the quantity of gold, there isn’t much room for discretionary policy. The United States operated under a gold standard from 1879 to 1914. And since the United States did not have a central bank during that period, there was no entity to undertake discretionary monetary policy. You can’t get much more rules based than that.
How did this arrangement work out for the United States? Not too well. The US suffered continuous deflation from the mid-1870s until the the early 1890s (the period was known as the “Great Depression” before the collapse of the 1930s took the name)–and major financial crises in 1893 and 1907.
Nor did the gold standard generate economic stability during the interwar period. Countries that remained on the gold standard the longest (e.g., Belgium, France, the Netherlands) experienced more severe declines in output than those that left relatively rapidly and were able to run a looser monetary policy.
Taylor’s designation of various periods as being characterized by rules-based monetary is arbitrary and inaccurate. The monetary policy that led to high inflation and contributed to high unemployment during the late 1960s and 1970s was certainly discretionary. The anti-inflation policy adopted by Paul Volcker and the Fed in the the late 1970s was also discretionary. The same thing can be said about monetary policy under Greenspan and Bernanke. What Taylor meant was that, in retrospect, policy under Volcker and the early years of Greenspan was “good” and the decade or so before and after was “bad.” That would have been more accurate.
Taylor is similarly off-base when he suggests that the Fed’s only mandate should be long-term price stability–a definition which he makes elastic enough to be less-than-meaningful. All signs suggest that the economy is fragile. Monetary policy can help to strengthen it. Taylor argues that when the Fed has to tighten up on monetary policy, as it eventually will, this will force banks to reduce their lending. Given that banks are not exactly lending out money hand over fist, this concern is premature to say the least. There was similar anti-inflation agitation following the tentative recovery during 1934-36. The devastating recession of 1936-37 quieted those voices; will it take a return to recession to get John Taylor to rethink his position?
Finally, Taylor stumbles in his accusation that Fed policy is unstable and unpredictable. Ben Bernanke has been, without question, the greatest champion of transparency at the Fed in its nearly 100 years of existence. He is the first Fed Chairman to hold a press conference after gatherings of the Fed’s policy-setting committee, the Federal Open Market Committee (FOMC). He has given a series of lectures, explaining the reasoning behind Fed decisions–an unprecedented step. And the FOMC has taken the novel step of announcing what interest rate policy will be over the next year to two years.
John Taylor should pay more attention to the facts.