The search for “the” rule goes on

John Taylor never misses a chance to remind everyone that “salvation” will be forthcoming when his rule is brought back. In his latest: “A Small Step Toward Monetary “Coordination” at the G-20?” he writes:

But I think it is more than simply a diplomatic effort to seek a more agreeable tone.  The central bankers and finance ministers seemed actually to agree that a gradual and transparent tapering of UMP is appropriate now, regardless of what they think of the past effects of UMP.

It also gives more meaning and credibility to the boilerplate pledge repeatedly appearing in recent statements that “monetary policy settings will continue to be carefully calibrated and clearly communicated.”  It perhaps is even a small step toward a bit more coordination in the sense used in a BIS paper I presented to central bankers gathered in Switzerland last June: “Going forward the goal should be an expanded rules-based system similar to the 1980s and 1990s which would operate near an international cooperative equilibrium. International monetary policy coordination—at least formal discussions of rules-based policies and the issues reviewed here—would help the world get to this desirable situation.”

Recently I wrote an extended post on Taylor´s conclusion on the “macro model wars”:

I do not see the evidence that these models led policy makers astray or were a cause of the financial crisis. To the contrary I have argued that the general policy recommendations of these models—which generally took the form of particular monetary policy rules for the interest rate instrument—were not followed by policy makers in the years leading up to the crisis though they followed them during the Great Moderation.Ignoring the recommendations was the problem rather than the recommendations themselves. These models did not fail in their recommendations. Rather the policymakers failed to follow the recommendations.

But as the chart shows, if the Fed were following the rule after late 2007 things would likely have been much worse. All the way to the ‘brink’, the “rule-rate” (the counterfactual rate) was significantly above the actual rate.

Search for rule

As Mishkin reminded all FOMC members in his “farewell” (or “valedictory”) speech during the August 5 2008 FOMC meeting:

First of all, let me talk about the issue of focusing too much on the federal funds rate as indicating the stance of monetary policy. This is something that’s very dear to my heart. I have a chapter in my textbook that deals with this whole issue and talks about the very deep mistakes that have been made in monetary policy because of exactly that focus on the short-term interest rate as indicating the stance of monetary policy. In particular, when you think about the stance of monetary policy, you should look at all asset prices, which means look at all interest rates.

The stance of monetary policy was incredibly tight during the Great Depression, and we had a disaster.

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