“What the world needs now…“

…is not Love, but NICE Monetary Policy according to John Taylor. NICE, actually NICE2,stands for:

  1. international monetary policy system that’s “near an internationally cooperative equilibrium”, and
  2. It would have the macroeconomic outcomes of “non-inflationary consistent expansion”.

Mr. Taylor has long been the most outspoken advocate of adjusting interest rates according to a mathematical formula (the most famous such formula was proposed by Mr. Taylor himself and is known as the Taylor Rule). Such rules, he argues, lead to policies that are more predictable and thus lead to better macroeconomic outcomes, namely low inflation and consistent growth.

Barry Eichengreen does not agree. In “The rules of central banking are made to be broken” he writes:

The Federal Reserve’s Jackson Hole conclave may be dominated by technical discussions of abstruse concepts such as the non-accelerating inflation rate of unemployment, but one also detects an undercurrent of nostalgia. Central bankers are wistful for a past when monetary policy was conventional and its makers could focus on adjusting interest rates.

Specifically, the assembled are eager to end the extended period of zero interest rates. They want to wind down their purchases of mortgage-backed securities and asset-backed commercial paper. These programmes involve interventions in financial markets. They may have undesirable side effects, encouraging investors to over-reach in the search for yield. Their benefits can be questioned. Policy makers are anxious to bring them to an end.

This instinct has led to calls, not least in the Federal Open Market Committee, for the US central bank to raise interest rates. It has prompted a noisy minority within the Bank of England’s Monetary Policy Committee to do likewise. It has discouraged the European Central Bank from pursuing unconventional policies of its own.

It is a dangerous sentiment, this yearning for an idealised past in which central bankers could focus on moving rates by a notch or two, this way or that – much as a physician adjusts the drugs administered to a patient with high blood pressure.

Making monetary policy has always been a complicated craft. Whenever there was an effort to reduce the art of central banking to a simple formula, be it an exchange rate target under the gold standard or an inflation target more recently, other problems – such as threats to financial stability – have had an awkward tendency to intrude. They will undoubtedly do so again. That should be a caution to those seeking to tie the Fed to algorithms such as the Taylor rule, a simple formula that purports to say how interest rates should respond to changes in inflation and output.

Milton Friedman was among the sage observers who were careful not to take the models too literally. As early as the 1940s, he understood that uncertainty about the structure of the economy was too great. But the spurious precision of these techniques, and the false scientism to which they gave rise, encouraged central bankers to believe that their job was to implement an optimal feedback rule, barely more complex than the one that switches on the compressor before the contents of the icebox begin to melt.

Market Monetarists say: You want NICE? Charge the central bank with maintaining Nominal Stability.

PS As I posted some months ago, the search for the “Holy Grail” is doomed!

2 thoughts on ““What the world needs now…“

  1. Okay…we tighten money globally, lowering growth and inflation expectations…leading to lower interest rates…wait! We want higher interest rates so we tighten money….

  2. Kenneth Rogoff wrote a new essay. What is the Market Monetarist take? This doesn’t feel quite right to me:


    “In the years preceding the financial crisis, increasing globalization and technological advances made it much easier for central banks to deliver both solid growth and low inflation. This was not the case in the 1970s, when stagnating productivity and rising commodity prices turned central bankers into scapegoats, not heroes.


    As it turned out, the euro was not quite the free lunch that it seemed to be. The gain in inflation credibility was offset by weak debt credibility. If the European periphery countries had their own currencies, it is likely that debt problems would morph right back into elevated inflation.”

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