The U.S. government and the Federal Reserve’s less predictable and interventionist policies since the start of the financial crisis could harm future economic performance, said John B. Taylor, creator of the Taylor Rule for guiding monetary policy.
“I am concerned about the direction of policy,” Taylor, a Stanford University economist, said in the text of a speech today in Denver. “History calls out economists, regardless of specialty, to explain the costs of moving policy too far in the interventionist direction, too far away from rules.”
Taylor, a former Treasury undersecretary, blames the Fed’s low-interest rate strategy under former Chairman Alan Greenspan for inflating housing prices. Taylor said President Barack Obama’s stimulus program and the Fed’s large-scale bond purchases are examples of a “dramatic shift” toward discretionary policy and are too focused on “short-term fine-tuning.”
The Taylor rule prescribes how a central bank should adjusts its interest rate policy in a systematic way in response to inflation and macroeconomic activity. Taylor reviewed six decades of U.S. policy in his speech and contrasted rules-based decisions with discretionary ones that affected unemployment, inflation and strength of recoveries.
“The historical swings away from rules have been damaging whether during the Great Inflation of the 1970s or the recent Great Recession,” Taylor, 64, said at the Allied Social Science Association’s annual meeting. The U.S. veered from discretionary policies during the 1960s and 1970s, to more rule-based policies in the 1980s and 1990s, back to a ”highly discretionary,” approach, the economist said.
The wage and price controls of the 1970s were “perhaps the epitome of interventionist policy,” with the Fed taking an “unstable” response to inflation until Paul Volcker became chairman from 1979 to 1987 and imposed a more rules-based approach, he said.
“The past 60 years reveals a clear positive correlation between rules-based policy and good economic performance,” he said. “In my view, this correlation is best explained by a causation from policy to performance.”
He said that discretionary policies of the Fed did not prevent the financial crisis that began September 2008. “In my view they were likely a cause of the panic, or at least made it worse,” Taylor said.
Fed Chairman Ben S. Bernanke and other Fed officials continue to defend a second round of Treasurys purchases — $600 billion through June — to spur the recovery and meet the Fed’s mandates of full employment and stable prices.
Bernanke said today in testimony to the Senate Banking Committee that the unemployment rate will probably fall slowly even with a pickup in U.S. growth this year, signaling no change in the central bank’s monetary stimulus.
The Labor Department today reported that employers added 103,000 workers to payrolls in December, less than the 150,000 gain forecast by economists in a Bloomberg survey. Today’s report also showed the jobless rate fell to 9.4 percent from 9.8 percent the previous month.
Charles Evans, president of the Fed’s Chicago regional bank, were set to speak later today at the conference and Fed Vice Chairman Janet Yellen will speak tomorrow.
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