One of the most fascinating aspects of the blogosphere is the phenomenon of the cross-blog conversation. It becomes even more interesting when the participants in the conversation are at the level of John Taylor and David Altig. If you’re not aware of them John Taylor is a Stanford econ professor, frequently mentioned as a possible successor to Ben Bernanke as chairman of the Federal Reserve and David Altig is the senior vice president and research director at the Atlanta Fed. Taylor is perhaps best known for the Taylor rule, a prescription for a strictly rule-based Fed policy in which the Fed would change the nominal interest rate based on inflation and GDP.
The first salvo in the conversation was an op-ed from Dr. Taylor in the Wall Street Journal which urged a twinned long-term approach for restoring growth to the U. S. economy with a fiscal component that included entitlement reform and a monetary component that encouraged more rules-based policy on the part of the Fed. Dr. Altig responded by asserting that the Fed of the early Aughts did, indeed, conform to a rules-based policy. Dr. Taylor then retorted with citations that suggested that Fed policy of the period (which differed from the Taylor Rule) was responsible for fully two-thirds of the housing bubble.
That presents an intriguing counter-factual for contemplation. Presumably, no housing bubble, no financial crisis. However, since much of the economic growth of the Aughts and, particularly, the growth in employment was tied closely to the housing bubble, wouldn’t even worse employment growth than actually have occurred produced a political crisis? 2004 certainly would have looked a lot different without a housing led recovery.
I’m not suggesting that the Fed intentionally set out to get George W. Bush re-elected or that the Fed should act for such reasons, merely that incumbent presidents are the beneficiaries of Fed policies that produce near term growth even if the long term consequences are ghastly.