From Taylor´s op-ed at the WSJ:
Unfortunately the Fed has returned to its discretionary, unpredictable ways, and the results are not good. Starting in 2003-05, it held interest rates too low for too long and thereby encouraged excessive risk-taking and the housing boom. It then overshot the needed increase in interest rates, which worsened the bust. Now, with inflation and the economy picking up, the Fed is again veering into “too low for too long” territory. Policy indicators suggest the need for higher interest rates, while the Fed signals a zero rate through 2014.
For all these reasons, the Federal Reserve should move to a less interventionist and more rules-based policy of the kind that has worked in the past. With due deliberation, it should make plans to raise the interest rate and develop a credible strategy to reduce its outsized portfolio of Treasurys and mortgage-backed securities.
History shows that reform of the Federal Reserve Act is also needed to incentivize rules-based policy and prevent a return to excessive discretion. The Sound Dollar Act of 2012, a subject of hearings at the Joint Economic Committee this week, has a number of useful provisions. It removes the confusing dual mandate of “maximum employment” and “stable prices,” which was put into the Federal Reserve Act during the interventionist wave of the 1970s. Instead it gives the Federal Reserve a single goal of “long-run price stability.”
Coincidentally, Scott Sumner recently wrote a post entitled: “John Taylor on monetary policy in 2008”.
Between 2008 and 2009 NGDP fell at the fastest pace since the Great Depression. That suggests that monetary policy was probably too tight in 2008. Oddly, John Taylor seems to think money was too easy…
The Fed “messed up” the moment it let money supply growth reverse while velocity was falling. At the time that happened the Fed was giving excessive attention to oil (and commodity) prices, just as Taylor does in his 2008 piece!
Below is the illustrative picture. Note that Taylor´s rates “too low for too long” period matches exactly the interval during which NGDP was climbing back to trend. So it seems “low rates” was exactly what was required. Under his namesake rule, which indicated a much higher FF rate, it´s unlikely that would have occurred.