Professor John Taylor of Stanford is a menace. Just when conservatives are beginning to understand the mortal threat to free market capitalism posed by the Fed he comes out peddling a new version of his statist “selfie” known as the Taylor Rule. Instead of drastically shrinking the scope of central bank price administration in the financial markets, Professor Taylor simply purposes a more “enlightened” version of the Greenspan/Bernanke/Yellen usurpation of the free market and honest price discovery on Wall Street.
The very first sentence of his recent article promoting a bureaucratic puzzle palace called the “Federal Reserve Accountability and Transparency Act of 2014” betrays his statist intent. He argues that if the Fed would only embrace the wisdom of certain monetary rules based on his superior research, the US economy would perform much better:
A lot of research and experience shows that more predictable rules-based monetary policy leads to better economic performance—both in terms of price stability and steadier-stronger employment and output growth.
That’s the problem right there. A central bank which aims to improve on the “performance” of the macro-economy is the enemy of the free market. In order to manipulate and target economic outcomes like GDP, jobs, housing starts, consumer spending and capital investment, an activist central bank must perforce destroy the financial markets which are at the heart of capitalism.
And “destroy” is not too strong a term because at the end of the day there are only two options. On the one hand, the monetary politburo in the Eccles Building can set the price of money, debt, the treasury yield curve and the host of financial assets which are valued with reference to them. In the alternative, they are the spontaneous result of “price discovery” in which millions of traders, investors and speculators find market clearing prices for financial assets and instruments–even ones that are not pleasing to PhD economists promising unicorns and unwavering prosperity.
Thus, if money market rates (e.g. Fed funds and related short-term paper) soar to 15 or 20% because too many speculators are piling into the carry trades—so be it. And if a market driven surge in the cost of money results in some broken furniture on Wall Street or the bankruptcy of gambling houses that found their carry trades upside down when the money market storm hit their balance sheets— that’s how the market self-regulates financial gambling and maintains long-term “stability”.
After decades of mission creep and the near religious embrace of interest rate pegging by the denizens of the Eccles Building, however, the very idea of honest price discovery on Wall Street and in the banking system generally has long been forgotten. It has been completely suffocated and displaced by the necessities of macro-economic management.
But once upon a time there was an alternative model called the “bankers’ bank” that was actually embodied in the 1913 legislation which created the Fed. Its purpose was to provide standby liquidity to the banking system on a passive basis. That is, it had no target for interest rates; they were given by the market. Likewise, it had no target for money supply or “financial accommodation”; the “reserve banks” were to supply cash to member banks at a penalty rate which floated above the market, and only on the basis of good commercial paper and receivables that originated in the ebb and flow of commerce.
Accordingly, the bankers’ bank had no place for the Taylor Rule because it was not in the business of managing capitalist prosperity. Instead, the level of GDP, jobs, inflation, capital spending, housing starts, retail sales and all the rest of the “incoming data” that the Fed gums about at every meeting were none of the central bank’s business; they were natural spontaneous outcomes on the free market resulting from the interaction of millions of producers, investors, consumers, savers, entrepreneurs and speculators.
But here’s the thing. The bankers’ bank as conceived by the great American financial statesman, Carter Glass, didn’t need any PhD economists to run it; it was simply the servant of main street industry, commerce and banking intermediaries. Likewise, it cared not a wit about Wall Street or the government bond market—it was not actually even allowed to own government debt. And most certainly the idea of a “put” under the stock market and the “wealth effects” doctrine of present times would have been viewed as incomprehensible babble.
Instead of targeting the Russell 2000, the humble job of central bankers as envisioned by Carter Glass was to put on green eye shades and examine the soundness and safety of the commercial collateral brought to the discount window by member banks. There was no committee to save the world here; no masters of the universe who would pretend to manage the nation’s income and wealth.
By contrast, professor Taylor’s swell new plan is just one more version of monetary central planning; one more nail in the coffin of healthy, stable, productive capital and money markets; and one more route to statist management of the nation’s economy with its attendant ills of crony capitalism and the transformation of financial markets into gambling casinos enabled by the central bank.
Besides that, the machinery he proposes is truly ridiculous. Let his own description form the indictment:
So it is good news that today the ‘‘Federal Reserve Accountability and Transparency Act of 2014” was introduced into Congress. It requires that the Fed adopt a rules-based policy.
In particular, Section 2, the first main section of the Act, titled “Requirements for Policy Rules for the Federal Open Market Committee,” would require that the Fed “submit to the appropriate congressional committees a Directive Policy Rule… which shall describe the strategy or rule of the Federal Open Market Committee for the systematic quantitative adjustment of the Policy Instrument Target to respond to a change in the Intermediate Policy Inputs.” Thus the rule would describe how the Fed’s policy instrument, such as the federal funds rate, would change in a systematic way in response to changes in the intermediate policy inputs, such as inflation or real GDP. The rule would also have to be consistent with the setting of the actual federal funds rate at the time of the submission.
The Fed, not Congress, would choose its Directive Policy Rule and how to describe it. But if the Fed deviated from its rule, then the Chair of the Fed would have to “testify before the appropriate congressional committees as to why the [rule] is not in compliance.” The Comptroller General of the United States would determine whether or not the Directive Policy Rule was in compliance and report to Congress.
To provide some flexibility the legislation allows for the Fed to change the rule or deviate from it if the Fed thought it was necessary. As stated in the legislation: “Nothing in this Act shall be construed to require that the plans with respect to the systematic quantitative adjustment of the Policy Instrument Target be implemented if the Federal Open market Committee determines that such plans cannot or should not be achieved due to changing market conditions.” But “Upon determining that plans…cannot or should not be achieved, the Federal Open Market Committee shall submit an explanation for that determination and an updated version of the Directive Policy Rule.”
An interesting part of the requirement is that the “the report to the congressional committees must include a statement as to whether the Directive Policy Rule substantially conforms to the Reference Policy Rule and with an explanation or justification if it did not. What is the reference policy rule?
According to the legislation “The term ‘Reference Policy Rule’ means a calculation of the nominal Federal funds rate as equal to the sum of the following: (A) The rate of inflation over the previous four quarters. (B) One-half of the percentage deviation of the real GDP from an estimate of potential GDP. (C) One-half of the difference between the rate of inflation over the previous four quarters and two. (D) Two.
So it’s the Taylor Rule. Of course the legislation does not require the Fed to follow the Taylor rule, but only to describe how it might differ. Describing this difference is a task undertaken as a matter of course by most researchers working on different policy rules, so it is a straightforward task for the Fed.
Only an academic power-seeker could come up with a Rube Goldberg contraption that ludicrous. Just re-read the policy rule in the second paragraph above: the four-quarter rate of inflation when there are 27 different versions published by the government statistical mills—all of which have been manipulated and deformed over the years; one-half the deviation of national GDP from “potential” GDP which is un-measureable in a dynamic global economy; and a magic constant named “2”. At least he has the good grace to name this gibberish after himself.
