Why John Taylor might be a good choice for Fed chair
I’ve done a few posts expressing opposition to Kevin Warsh being nominated to chair the Fed. Now there are rumors that John Taylor’s stock is rising:
Stanford University economist John Taylor, a candidate for Federal Reserve chairman, made a favorable impression on President Donald Trump after an hour-long interview at the White House last week, several people familiar with the matter said.
Former Fed board governor Kevin Warsh has meanwhile seen his star fade within the White House, three of the people said. They would not say why but Warsh’s academic credentials are not as strong as other candidates, and his tenure on the Fed board has been criticized by a diverse group of economists ranging from . . . [obscure nobodies] . . . to Nobel laureate Paul Krugman.
I had several problems with Warsh. He doesn’t have expertise on monetary economics, he didn’t do well during his stint at the Fed, and I worried that he might be more “political” than Bernanke and Yellen.
I have much less concern about Taylor. I believe that Taylor (and most other conservatives) missed the boat during the Great Recession, and was excessively worried that QE would lead to high inflation. But he is also extremely smart and well-qualified, and a person who is likely to keep the Fed out of politics. While the Taylor Rule is not the specific policy I favor, he’s a strong advocate for a rules-based approach.
Here’s why I think Taylor might be a good choice, despite my reservations about the Taylor Rule:
1. Fed chairs are generally not dictators, but work with a very well entrenched Fed establishment. Thus I would not expect Taylor to come right in and install the Taylor Rule.
2. Point one might seem like a weak argument in his favor, but I’m also thinking about the fact that the current Fed is not sufficiently rules-based. If Taylor and the Fed met halfway, it might well be a policy I could support wholeheartedly. In other words, I see Taylor as someone who might nudge the Fed toward a more rules-based approach.
3. The Fed has a 2% inflation target, and I’d expect Taylor to take that target quite seriously. Thus I’m not all that concerned about whether policy is “hawkish” or “dovish”, I want a more stable monetary regime. It’s not the end of the world if core inflation average 1.8% instead of 2% over the next 10 years (although I’d prefer they hit their targets), but it would be really bad if the core inflation rate became highly unstable, and also procyclical.
4. If (as I expect) Taylor were not able to immediately install his preferred policy rule, I believe he’d look to make progress in other areas. One obvious choice would be to adopt some of the accountability measures that I have advocated. These would make policy more disciplined and rules-based, without going all the way to a rigid mechanical formula. Policymakers would have to provide a clearer sense of what macroeconomic outcomes they are trying to achieve, and how they see their instrument setting enabling those outcomes.
5. Another possibility is Bernanke’s modified price level targeting proposal, which would make policy more accountable and rules-based at the zero bound. That sort of policy would have reassured conservatives who worried about the risk of high inflation back in 2010, while actually providing additional stimulus. Under level targeting there is basically no long-term inflation risk. Also recall that Taylor said good things about NGDP targeting during the 1980s, so that’s another possible direction for reforms.
To summarize, rather than think about a new Fed chair in isolation, we should think about the outcome of the new chair interacting with the existing structure of the Fed. In the post title I said Taylor “might” be a good choice. In this sort of area one can never be certain, but my instincts tell me that he’d nudge the Fed a few degrees toward a rules-based policy approach, which is exactly what the Fed needs.
PS. Don’t take this post as an endorsement of Taylor as my first choice, rather I’m responding to the perception that I would oppose Taylor. Not true.
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16. October 2017 at 14:24
The market sees Taylor as a monetary policy hawk, or at least for tighter monetary policy than now. I tend to agree and would argue that Taylor will not simply change his views of the last twenty years because he’s now Fed Chair.
Ask yourself, Mr. Sumner, if you would change your entire view of NGDP targeting if a crisis occurred and the situation appeared to not support your views. Would you choose a radical new and untested path, or stick to what you know?
Taylor will lead to higher interest rates and a less responsive Fed than a Yellen or Powell Fed. Even Warsh might be more dovish than Taylor. Then again, who knows what’s possible nowadays. We have a sexual offender as President, white supremacists running over protestors, and BLM shutting down even liberal professors.
16. October 2017 at 14:47
To worry (as Alec and many others do) that Taylor will raise interest rates is to overlook the fact the the Fed, right now, under Yellen, is anticipating raising rates by about 175 basis points over the next couple years as part of what it calls “normalizing” monetary policy. It is highly doubtful that Taylor would seek to increase them more rapidly than that! On the contrary: bot because he takes the inflation target seriously, and because, unlike the Fed’s present administrator, he isn’t so determined to maintain an IOER-based “floor” regime, which practically requires an above-market IOER (“fed funds”) target, he may actually be less likely to stick to such an aggressive IOER-rate hike schedule.
In any event it’s wrong, as Scott appreciates, to reduce the matter of choosing the next Fed chair a simple one of hawk-v-dove. It is a question of the general principles that will drive the conduct of monetary policy going forward.
16. October 2017 at 14:52
Alec, See George Selgin’s reply. It’s not about hawks vs. doves.
16. October 2017 at 16:16
How can anyone that believes in capitalism think that long term capital formation can function properly w a decade+ of negative short term real yields. The idea that central banks can control inflation in a world of globalization, automation, and digitalization
16. October 2017 at 16:18
Meh. Prefer to see a pro-growth advocate in the Fed Chair. Someone willing to take chances to promote growth.
Curiously, academics might be the wrong choice for the Fed chair. Consider Martin Feldstein or Charles Plosser. Academics tend to become doctrinaire, even dogmatic. Ossified myopia.
Why the fetish for such precise rates of inflation?
If real growth can be maintained near 3%, what does it matter if inflation is 1%, 2% or 3%?
16. October 2017 at 16:20
Is absolutely crazy. Monetarism is wrong, there is so much empirical evidence for the dominance of non monetary drivers of inflation that those that continue to believe in it have lost the ability to question their narratives.
Money is meant to be a technology that humans use to exchange and value goods/services/assets. That is why central banks are really only effective during liquidity crises…or at forcing negative real yields/subsidizing debt vs equity..
16. October 2017 at 16:22
The first line of #3 is important. Though on the surface that doesn’t imply that Taylor would have avoided the 2007-08 downturn and crisis. The Bernanke Fed took the implicit 2% inflation target seriously too. They just screwed up on the actual policy and the announcements of policy. One can take a target seriously without knowing how one is screwing up ability to meet the target.
16. October 2017 at 16:40
To worry (as Alec and many others do) that Taylor will raise interest rates is to overlook the fact the the Fed, right now, under Yellen, is anticipating raising rates by about 175 basis points over the next couple years as part of what it calls “normalizing” monetary policy. It is highly doubtful that Taylor would seek to increase them more rapidly than that!
But that’s not really the concern. Maybe he wouldn’t be more hawkish in the world where everything proceeds exactly according to plan (whatever that turns out to mean) under the Yellen fed, but that is only one of many worlds, and not the most worrisome. Although I agree that it isn’t or shouldn’t be Hawk versus Dove if (say) the Taylor rule happens to be benign, that is certainly something it can become under the wrong people encountering the wrong conditions.
John Taylor has claimed that one of the Fed’s big mistakes was being too easy during 2008, causing a rise in oil prices. He has also claimed in evaluating his signing of the famous QE inflation warning to Bernanke that he successfully predicted the QE would cause a slow recovery, but said nothing about his inflation warning. He also repeatedly called for higher interest rates when the Taylor Rule appeared to suggest them, even when nominal expectations were plainly below trend.
On the other hand, he never once that I recall called for lower interest rates or easier monetary policy, even though there were ample opportunities to do so during the past ten years, including for someone rigidly wedded to a Taylor Rule or an inflation target. If he were as rules-based and principled as he claims, his mistakes would have been less asymmetric. Just because someone says they are rules based or even thinks they are rules based doesn’t mean they are.
I understand the general preference for principles over discretion. But a lot of damage can be done in the name of principle when your basic view of the world isn’t about stabilizing the nominal spending trend. The supposedly positive halfway house that Scott imagines between discretion and rules can be a disaster if it means you have just enough discretion to implement a bad model and just enough principle to override any hope that your pragmatism kicks in and saves you. Pragmatism is arguably what saved Greenspan from his so-so model of the world.
Maybe John Taylor would turn out to have it, too, but he doesn’t seem like great candidate based on his public statements. There are a lot of open spots on the Fed. Maybe one chair slot isn’t a big deal or maybe it is. I think you rarely know for sure what kind of a Fed chair someone will be until you see their model of the world tested against shrouded changes in nominal expectations that don’t show up the way you expected them to. I think Taylor is a really dangerous choice.
In the last ten years we had some of the most severe hawkish policy errors in our lifetimes, both here and in Europe. Can we find a single instance during that period of Taylor calling policy too tight?
16. October 2017 at 21:32
“Can we find a single instance during that period of Taylor calling policy too tight?”–dlr
Indeed. There was a time when a “right-winger” academic might have chastised the Fed for being too tight.
See Milton Friedman:
https://miltonfriedman.hoover.org/objects/56910/too-tight-for-a-strong-recovery
Harry Johnson, a lion in right-wing macroeconomic circles a few decades back, laughed at right-wingers for peevishly fixating on inflation at the cost of real growth.
Taylor himself gushed about Japan’s first QE programs back in 2006.
https://web.stanford.edu/~johntayl/Onlinepaperscombinedbyyear/2006/Lessons_from_the_Recovery_from_the_Lost_Decade_in_Japan-The_Case_of_the_Great_Intervention_and_Money_Injection.pdf
But today, right-wing academics have become strident, dogmatic. It is no longer PC to credit QE for revival. Why this new zealous doctrinaire approach? I am not sure. Something to do with polarization, or funding of think tanks?
Macroeconomics is often just politics in drag. Maybe usually.
17. October 2017 at 03:59
http://archive.is/
17. October 2017 at 05:34
The only real “Taylor rule” I learnt from his blog so far is that according to him money is never too tight, which is rather underwhelming.
17. October 2017 at 08:09
Have to agree with Christian here.
Unless I’m mistaken he’s favored tighter money throughout the entire Great Recession. The issue isn’t that he’s a hawk, it’s that being in favor of tighter policy since 2008 has been indefensible. I worry he would be a force for bad should another recession happen in the next five years, as is likely.
17. October 2017 at 08:38
[…] Scott Sumner on John Taylor as Fed chair. And Scott goes to a Peterson Institute […]
17. October 2017 at 10:34
Miguel,
Since the FED can print or destroy practically unlimited amounts of cash, who in their right mind would think that they aren’t able to control the value of cash?
17. October 2017 at 12:27
Reading several comments here that Taylor is a perma-hawk, I went to check out his blog and found the following paean to the sort of consensus building, scientific, rule-based approach that Scott is hoping for from Taylor: https://economicsone.com/2017/07/31/still-learning-from-milton-friedman-version-3-0/
Here’s hoping…
17. October 2017 at 15:07
Cameron Blank:
“I worry he would be a force for bad should another recession happen in the next five years, as is likely.”
If we’re already in a boom, or liable to begin one shortly, then wouldn’t all this concern over interest rates getting too high (or Taylor ending up as Fed chair) be misplaced?
17. October 2017 at 17:23
Remember when the usual yokels dismissed this as a conspiracy theory when I posted it here?
http://thehill.com/policy/national-security/355749-fbi-uncovered-russian-bribery-plot-before-obama-administration
17. October 2017 at 17:24
Randomize:
The value of money is controlled by producers of real goods and services, not counterfeiters.
17. October 2017 at 17:26
The current favorite for the next Fed chair is………Jerome Powell.
https://www.predictit.org/Market/3306/Who-will-be-Senate-confirmed-Fed-Chair-on-February-4%2c-2018
17. October 2017 at 17:29
“Horse race for Fed chair pits Warsh against mentor and brings Yellen back”
https://www.cnbc.com/2017/10/16/horse-race-for-fed-chair-warsh-mentor-yellen.html
17. October 2017 at 17:30
“Powell likely next Fed chief, though Yellen best suited: economists”
https://www.cnbc.com/2017/10/17/powell-likely-next-fed-chief-though-yellen-best-suited-economists.html
17. October 2017 at 19:06
Mark,
I suspect sometime in the next 4 or 5 years the boom will end and another recession will occur. Recessions tend to happen every 7-8 years and we are almost 8 years into this recovery.
17. October 2017 at 19:16
I am hoping the next Fed chair has a mop of white hair.
17. October 2017 at 22:01
Cameron,
But booms and recessions aren’t geological events with a fixed temporal cycle. They occur (at least if one believes they do occur; this is Scott Sumner’s blog after all) when markets overheat; but how could said overheating happen if a hypothetical Chairman Taylor kept interest rates high? If we are indeed in a boom, would he not merely be engaging in counter-cyclical monetary policy?
18. October 2017 at 02:01
Among other things, Taylor was a the go-to economist for blaming Greenspan for the housing bubble. It’s very wrong for many reasons.
http://www.aei.org/publication/how-the-fed-helped-cause-the-housing-bubble-and-financial-crisis/
The Taylor rule itself is wrong for many reasons. It assumes a long-term real interest rate of 2% and that it will stay fixed there no matter what. The rest of the rule follows from that wrong assumption. For the rest of the rule, determining the correct inflation and output gap measures isn’t a hard science.
At least with Taylor’s choice of data sources, the rule gives a really odd recommendation. It says policy was too tight throughout the 90’s and too loose 2003-05. Now, the Fed does not act in isolation. Lowering rates by 2 points in the 90’s would have created inflation which would have pushed up the Taylor rate. Still, the policy would have been worse than either direct level targeting or human judgment.
https://www.brookings.edu/blog/ben-bernanke/2015/04/28/the-taylor-rule-a-benchmark-for-monetary-policy/
In practice, the rule is used as an asymmetric VSP bludgeon. As another commenter asked, has Taylor ever called for lower rates? When the rule said extraordinary negative rates, did Taylor call for negative rates or other actions, such as QE or even fiscal stimulus? No, he opposed *all* action in 2009-10 past a zero percent rate.
With the “correct” policy according to Taylor, the Taylor rule would have had even deeper negative rates. The inflation and output numbers would have been even worse without QE1 or fiscal stimulus. Apparently, John Taylor would have let another Great Depression manifest itself completely unemcumbered.
18. October 2017 at 09:34
Mark,
I agree that recessions are probably avoidable, but given history, it seems recessions occur with reasonable frequency. Even the great moderation had a few, so I’m assuming we won’t go another five years without one. Whether the risk of a recession rises the longer a boom goes on or whether it stays constant is an interesting question.
Still, I wouldn’t trade someone who might be 10% better in boom times (I’m not even sure this is true, raising rates faster probably INCREASES the risk of recession) but 10% worse in recessionary times. Given how low rates are and how uncomfortable the Fed seems with low/zero rates, a poorly managed recession seems more costly than a poorly managed boom.
18. October 2017 at 11:06
dlr, You said:
“I understand the general preference for principles over discretion. But a lot of damage can be done in the name of principle when your basic view of the world isn’t about stabilizing the nominal spending trend. The supposedly positive halfway house that Scott imagines between discretion and rules can be a disaster if it means you have just enough discretion to implement a bad model and just enough principle to override any hope that your pragmatism kicks in and saves you. Pragmatism is arguably what saved Greenspan from his so-so model of the world.”
I agree that this is a risk, and that Yellen is a safer choice. But I also think there is more upside with Taylor
18. October 2017 at 11:30
Prof Sumner,
These are some good points I hadn’t considered. My main worries with Taylor, though, are that his conception of rules-based policy (instrument-based) differs much from yours (goal-based). Indeed, the letter he was a signatory to back in 2010 warning about the impending inflation risk of QE, rather than the muted outcomes — or, better, the market reaction — further attests to this rigid thinking. His rule, of course, also famously excludes time variation in r* and trend growth. (This could be fixed, of course, but I can’t imagine tying monetary policy explicitly to a model forecast.) Perhaps he and Jim Bullard could have a long discussion over this.
I also strictly recall Taylor giving congressional testimony to the effect of arguing that fiscal austerity would be expansionary by reducing interest rates. (I think he meant to say, ‘the Fed would offset it.’) There again is the logic of ‘low rates = easy policy = easy money,’ rather than the correct frame of thinking you regularly espouse that low rates are a consequence of overly tight policy.
I guess beggers can’t be choosers when Donald Trump is president. Prediction markets surprisingly have been buying Powell’s stock for quite a while. That’s a far safer option, I’d say.
18. October 2017 at 21:12
https://i.imgur.com/vkcENS7.jpg
19. October 2017 at 05:49
It’s hard for me to understand you sometimes Scott, other than you simply HATE being wrong, more than learning new stuff.
This is CARBON COPY of what i spent years yelling at you about how you SELL NGDPLT:
“Unfortunately, that post-crisis period merged into another pre-crisis period as monetary policy got off track again somewhere around 2003-2005. Many have documented a shift of policy away from rules as rates were held too low for too long. That finding holds for a variety of interest rate rules, including those that react to nominal GDP rather than to inflation and real GDP separately, as shown by George Selgin, David Beckworth, and Berrak Bahadir.”
http://web.stanford.edu/~johntayl/2017_pdfs/Remarks_on_Monetary_Rules_for_a_Post-Crisis_World-2017.pdf
RIGHT UP FRONT, Taylor BLAMES Fed for bad policy in 2003-5.
He makes it clear, RULES FOLLOWERS would reward those pulled their cash at right time, and DESERVED to GUT THE LOSERS in 2003-2005 would have gotten their gains…
He lets his distaste BE KNOWN FOR SUBPRIME DEMS & WALL STREET getting aided and abetted by the Fed.
!!This is what he likes MOST about NGDPLT!!
—-
And I told you over and over, stop appealing to the “Recovery at any cost” guys, and show everyone HOW your ideas would SHUT DOWN BAD POLITICS FOREVER.
You have this great story you can tell:
1. Once we adopt a 4.5% NGDPLT, Congress is now responsible for the Economic Mix of Inflation & RGDP
2. Bad Fiscal policy, creates a sh*t Equilibrium in Animal Spirits, we get .5% RGDP and Fed prints money to save us.
3. Good Fiscal policy gets us 4% RGDP and just .5% inflation.
1-2-3 THIS IS A GREAT STORY.
—-
The more responsible we MAKE CONGRESS FOR FISCAL, the MORE the INDEPENDENT Fed serves it’s TRUE political purpose!
Fed Chair Taylor sit down in front of Congress and says,
“We HATE that this terrible Govt is reducing Animal Spirits with their Regs and Taxes and can only deliver 1% RDGP, because we must now tax all Americans 3.5% inflation! SHAME ON YOU! FOR SHAME!”
—-
But Nooooooooo…. Scott you didn’t want to bend even a little…
You spent years saying we didn’t have a Housing Bubble and blah blah.
And you could have said UNDER NGDPLT, Congress will soon learn it cannot increase public employee wages UNLESS they deliver productivity gains because that is Fiscal INFLATION!
You should be Fed Chair.
NGDPLT is deeply conservative monetary policy and you refuse to embrace it.
20. October 2017 at 07:06
Taylor would be okay. I would guess Yellen will be staying. Let’s all just be very, very thankful we’re not going back on the gold standard next year. Eventually all advanced economies will get to something resembling NGDP trend targeting as the benefits become more obvious, but a lot of unnecessary pain will be haplessly inflicted along the way.
I suspect the choice of Fed chair is ultimately less important than that of the successor to Zhou Xiaochuan — he was a true reformer who understood that strict controls on capital movement and foreign exchange cannot long coexist with prosperity, and arguably the man most responsible for China’s success in evolving into a global manufacturing power. Unfortunately it’s not clear Xi Jinping understands or cares enough to allow any independence of thought or action that might threaten the Party’s grip on every lever of power. Unfortunately at this point every year they hide behind the peg probably makes their eventual emergence significantly more painful.