Was the “Considerable Period” or the “Measured Pace” More At Fault?

In his recent review in The New York Review of Books of my book Getting Off Track, Roger Alcaly makes a very interesting point about the “too low for too long” hypothesis, according to which the Fed helped cause the housing boom. I hear that some policymakers at the Fed have been thinking the same way in recent weeks. If so, then when the Fed starts increasing the interest rate, it is likely to do so faster than in 2004-2005. But first consider Roger Alcaly’s argument.

Alcaly agrees that the Fed held the federal funds interest rate too low for too long in 2003-2005, but he emphasizes the slow measured pace at which the Fed raised the rate (once it started raising it) rather than the long considerable period during which it held the rate low at one percent.

Alcaly puts it this way: “Taylor’s general contention that low rates after 2003 encouraged the housing bubble is largely persuasive, although mostly for different reasons than he provides.”

Alcaly points out that “the Fed raised rates only in increments of a quarter of a percentage point…. Fourteen of these “measured” rate rises were attributable to Greenspan and three to Bernanke, who replaced him in February 2006. Raising interest rates so slowly and steadily promoted excessive risk-taking, and should have concerned Greenspan, according to his stated views.”

Can one assess quantitaively whether the measured pace period was more to blame than the considerable period period? In my research, I use the deviations between the actual federal funds rate and the Taylor rule to measure whether rates were “too low for too long” as shown in the chart below. This same approach provides a metric to determine whether the deviations were larger before or after the interest rate started rising, and thereby assess which period was more to blame for the “too low rates.”

I have drawn in a red line in the chart below to indicate when the Fed started increasing the funds rate. Note that there is a big gap on both sides of the line. The cumulative deviations to the right of the red line (13.9 percentage points) are indeed sizeable as Alcaly argues. However, they are slightly smaller than the cumulative deviation on the left of the red line (15.5 percentage points).

So at least by this measure there is no reason to be more concerned about a repeat of the “measured pace” period as there is a repeat of the “considerable period” period.

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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