You might want to take a look at this post at Investopedia on the Taylor Rule:
First, AI came for our jobs, now it wants to set monetary policy. With Fed Chair Janet Yellen’s first term as the leader of the Federal Reserve Committee coming to an end, there talk President Donald Trump may appoint a new chairperson who would adopt a rules-based policy, essentially turning the Fed into a robot. Setting monetary policy this way would see the Fed adjust interest rates based on key economic indicators such as inflation, GDP, and the unemployment rate.
The most popular formula is the Taylor Rule, which would see the Fed set a real fed funds rate, usually 2 percent, and then derive the nominal rate using current inflation, inflation expectations, GDP and GDP expectations.
The graph at the top of this page illustrates what interest rate the Taylor Rule would have produced over time.
Here’s the question: would protracted negative interest rates have been worse than what actually happened? That boiled down to increased financialization of the economy, preservation of zombie banks, and subsidies for rich people and did not produce the economic growth predicted by the Fed governors. I open the floor for debate.
Yes, I think a negative interest rate would have been counterproductive. The experiment with such rates in Japan and Europe suggest that rather than incentivize spending the result was an increased rate of saving to compensate for what amounts to a tax on deposits.
It should be noted a Taylor Rule is based on the same New Keynesian/neoclassical thinking as we’ve already seen in monetary policy: that there is a magic moving level of return on capital, and if the interest rate is below that level then businesses will invest because the difference is guaranteed profit. As Dave points out we saw little to no empirical evidence over the last eight years to support this idea.
I don’t oppose rules-based regulation as such and I think that the Fed governors have flunked their most important test. I’m not sure how the rule should be tweaked but I’m not impressed by the results of negative interest rates, either. And quantitative easing has pretty clearly been a complete flop.
“that there is a magic moving level of return on capital, and if the interest rate is below that level then businesses will invest because the difference is guaranteed profit.”
As someone involved in business investment decisions for about 25 years now I know of no one who looks at it that way. No one. Perhaps there are some fancy arbitrage techniques involving liquid instruments, but blood and guts investing. No.
As someone involved in business investment decisions for about 25 years now I know of no one who looks at it that way. No one.
No, but economists sure do.
Which is why we need a lot more Fed governors who’ve been bankers or other business managers (as used to be the case) and fewer academics.
Amen. And look what an awful mess they have made the past 20 years. (Some would say quite a bit longer!)
“And look what an awful mess they have made the past 20 years. ”
Academics were running the big banks in the aughts? Who knew?
Steve
We’re talking about Federal Reserve governors, steve. Twenty years ago Alan Greenspan was chairman of the Fed. He’d had no practical experience as a banker or in other business. Prior to joining the Fed he’d been a researcher.
Just about 15 years ago Tim Geithner, the Forrest Gump of the financial crisis of 2007, became president of the New York Fed. He’d had no experience as a banker or in other business. He was basically a political apparatchik.
This has been a growing pattern with the Fed. Academics and apparatchiks.
Yellen: academic
Bernanke: academic
Greenspan: researcher
Volcker: academic and apparatchik
Williams: businessman
Burns: academic
Martin: businessman and apparatchik
McCabe: businessman
Eccles: businessman
See the change?
They are like the little girl in the backseat with her plastic steering wheel. Except, she knows she is not driving the car.
If you wanted to cozy up to the Wall Street bankers, you would appoint Timothy Geithner as Treasury Secretary.
I thought it was a reward for his years of service producing the financial crisis. It’s the sort of thing that makes you wonder whether the Peter Principle isn’t overly optimistic.
Dave- My point still stands. I don’t see how you make the case that things would be better if you put the bankers in charge who ran things in the early 2000s. They were passing out loans to people w/o even finding out if they had assets or income. They were passing out mortgages that were worth 25% more than the value of the homes upon which they were writing the mortgage. Really! Then they were surprised that they lost money on those loans. I wouldn’t let those guys run a local lemonade stand, and certainly not any public institution that had financial responsibilities.
Steve
PS- Left out one of the best. If I told you that I had 1000 loans out that individually each had a high chance of defaulting, they would become perfectly safe, AAA, in fact, if I lumped them altogether, would you believe that? The bankers did.
Steve
Steve