Taylor Is Questioning His Own Rule

Some members of Congress are trying, once again, to pass legislation to strip the Federal Reserve of discretion over how it manages monetary policy and to force it to adhere to rules instead. A measure has passed in the House that would require the Fed to follow a Taylor rule, named after Professor John Taylor of Stanford University, for adjusting policy interest rates. So it was extremely interesting to listen to Taylor, a candidate to be the next Fed chairman, make the case on behalf of his rule at the Boston Fed conference last week. It didn’t sell well, except to its previous supporters.

The Taylor rule ties changes in interest rates to how far unemployment and inflation deviate from their policy objectives. When unemployment is above target, or inflation below target, the guideline requires policy rates to be reduced to levels that would stimulate growth. This is, of course, precisely what the Fed has used its discretion over policy to implement. Taylor warrants that policy would be more transparent, predictable, accountable and effective if only the central bank rigidly followed his rule instead of adjusting policy based on the judgment of the Open Market Committee of the economy’s policy needs. It would give investors the ability to know well in advance precisely how policy would respond to changes in unemployment or inflation. The Fed would become more accountable, since it would be clear to all observers when it deviated from the rule. And according to Taylor, the policy results would be better, with the economy enjoying smaller deviations of unemployment or inflation from their targets.