John Taylor, Professor of Economics at Stanford University, may be the next chairman of the FED. That will be a wonderful thing, in my view. John Taylor’s impressive Curriculum Vitae is here, and a link to his one-page bio is there also.
John Taylor is responsible for the “Taylor Rule” or sometimes called the “Taylor Principle.” Don’t know what the Taylor Rule is? Well, it’s represented by an equation that I cannot possibly decipher and I was a math major in college. Fortunately, the intimidating equation hides the fact that the rule or principle is rather simple and easy to understand.
First, the goal of the Taylor Rule is to maintain price stability in the economy. There’s a concept for you. Second, let’s recall a couple of concepts, the Nominal Interest Rate and the Real Interest Rate. The nominal interest rate is the rate of interest you might pay and which the lender receives on a loan. The real interest rate is the nominal rate minus the rate of inflation. The real interest rate must be known in every transaction for the parties to know the actual cost to the borrower and the actual gain to the lender.
The rule is that for each one-percent increase in inflation, the central bank should raise the nominal interest rate by more than one percentage point. How much more? I don’t know. A little more, I think. Enough, it is said, to avoid the inefficiencies of “time inconsistency” from the exercise of discretion. I guess that’s a situation in which the FED’s preferences change over time in such a way that a preference can become inconsistent at another point in time. What worked last month won’t work this month, so follow a consistent rule to even it out. Milton Friedman said the FED should be replaced by a computer. It would increase or decrease the money supply in accordance with a consistent rule. Computers don’t act discretionarily. Most of the time.
Think of breakfast at a cafe. You order coffee with your eggs, the waitress brings the eggs but forgets the coffee. She brings the coffee later after you’ve finished your eggs but you’re running late and you have to leave. They don’t offer take-away cups. Under the Taylor Rule for cafes she was supposed to deliver the coffee with the eggs.
Is it really that simple? No, or that horrid equation would not exist. I may be chastised for making it look so simple, but that’s the gist of it and for my money, it’s what we need to know.
Those as old as I am will remember that during the Carter administration in the late 1970s we were getting an 18% return on our money invested in a money fund. Whoopee, we thought! But wait, inflation was almost the same 18% as well. Drat! We were just treading water. We weren’t losing but neither were we gaining. We were merely keeping what we already had.
If we put our money in the mattress it would have slowly become worth less and less in terms of what we could buy with it. Thanks be to God that in 1980 a savior was born into the White House named Ronald Reagan. He and FED chairman Paul Volcker brought inflation under control, albeit only after some painful but necessary reckoning with the mess that had been created by the pre-Volcker FED and the bad economic policies of Nixon and Carter. That and the Reagan tax cuts then gave us the 1980s economy, one of the best ever. So good, some economists believe it continued for the next 25 years, well into the Bill Clinton presidency.
John Taylor has a blog he calls Economics One that I follow. It’s not always an easy read because it’s deep into the weeds of economic theory and monetary policy, but I manage. I’m pretty sure I understand what John Taylor writes better than Paul Krugman does, and Krugman won a Nobel Prize.
I suppose it’s not a done deal quite yet that John Taylor will be the next FED chairman, but I’m hopeful that he will be. His leadership at the FED is sorely needed, and Trump’s status as savior of the American economy will be enhanced.
I will personally benefit from a John Taylor appointment to the FED. I will finally be able to stop my yellin’ at Janet Yellen.