Recently I posted an exceedingly long piece criticizing interest rate targeting, so I won´t go over that. But John Taylor insists in thinking that his namesake rule is the world´s 8th wonder, being the cause of all evil when it was “discarded”.
His latest post draws on a new study that questions justifications for quantitative easing. According to Taylor:
Proponents of Quantitative Easing frequently cite—inappropriately in my view—the Taylor Rule as support, saying that the rule calls for a federal funds rate as low as minus 6 percent, well below the zero bound. But in various pieces over the past year, such as Taylor Rule Does Not Say Minus 6 Percent, I have argued the contrary. If you simply plug in current inflation and output (gap) you will find that the interest rate is above zero with the policy rule coefficients I originally derived. But QE II proponents change the coefficients. Frequently they use a higher coefficient on output (around 1.0) rather than the lower coefficient (0.5) which I originally recommended. The higher coefficient on output gives a much lower interest rate now and is thus used by proponents of quantitative easing.
A new paper by Alex Nikolsko-Rzhevskyy and David Papell provides important evidence relevant to this debate. They show that, if history is any guide, the higher coefficient would lead to inferior economic performance compared with the original coefficient I recommended.
The operative words are: “if history is any guide”. Unfortunately history ceases to be a guide when you create a “whole new world”. And that´s exactly what the Fed did when it allowed nominal spending (AD) to completely “derail” (to paraphrase Taylor´s “Getting off track”). The “interest rate tweaking”, harmless enough when the economy was “on track”, proves quite useless, no matter the “parameter values” you plug in, when a derailing takes place. At this point the “target” should be to put the “train” back on the “track”. For that a new set of “tools” is required. But the main thing to do is “define the target”. And obviously since you´ve veered far “off track” when you “derailed”, a “level target” should be your goal. Until you get back “on track”, forget about “targeting rates”. They´ll only succeed in keeping you (far) away from the right “track”.
Papell summarized the argument in this econobrowser guest post:
Variants of Taylor rules with larger output gap coefficients, which do produce negative interest rates, cannot be justified by historical experience. The Taylor rule does not provide a rationale for quantitative easing.