A Simple Rule for Monetary Policy After 20 Years

It was 20 years ago today at a conference in Pittsburgh that I first presented what is now called the Taylor rule. Here’s the November 1992 Stanford working paper. It’s nearly impossible to predict which ideas will be picked up by policy makers and which won’t, and I certainly didn’t predict in 1992 that the Fed and other central bankers would still be referring to the idea in 2012.

Last week, for example, the Taylor rule served as a reference point for two very different talks by two members of the FOMC. In a speech in Berkeley, Vice Chair Janet Yellen talked about forward guidance. She argued that the federal funds rate should stay below the Taylor rule for a while longer and even below a “Modified Taylor rule” with a higher response to the output gap. She said that “times are by no means normal now, and the simple rules that perform well under ordinary circumstances just won’t perform well with persistently strong headwinds restraining recovery and with the federal funds rate constrained by the zero bound.” So that means more discretion, and, in my view, more drag on the economy.

Philadelphia Fed President Charles Plosser also spoke about forward guidance last week, but he saw no reason not to use a policy rule under current circumstances, and he recommended setting interest rates according to one of those policy rules. That would bring a more rules-based policy, which experience over the past 30 years shows would be better for the economy, as I argued in a talk at the same conference where Charlie spoke.

New research by Kansas City Fed economist George Kahn provides highly relevant econometric evidence on the issue. In an article forthcoming in the Kansas City Fed’s Economic Review, he estimates simple policy rules over relatively well-performing periods. He finds that the estimated parameters over these periods are very close to those of the rule I proposed 20 years ago, though with a different constant term implying a higher equilibrium federal funds rate.

About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

Visit: John Taylor's Page, Blog

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