I have only had one class so far this semester so I have yet to really come to any conclusions on my professor. It is a banking and finance class. He assigned us something to read that surprised me a bit.
The document he gave to us to read is straight forward and easy to understand. The piece is by John Taylor and deals with suppressed interest rates over long periods which is nothing new to the Austrian.http://www.stanford.edu/~johntayl/FCPR.pdf . I don’t know much about John Taylor, but I think it is safe to say that he is not an Austrian. The “Taylor Rule” as it is known can be best summed up as what “the interest rate would have been if the Fed had followed the kind of policy that had worked well during the historical experience of the Great Moderation that began in the early 1980s” (quoted from the article).
I think the Taylor Rule is over simplistic and like so many other one size fits all government policies that don’t take into account the complexities in the economy. Sure, if interest rates would have begun to rise in 2002 as he suggests it most likely would not have led to the boom and bust (or at least not as extreme), but to assume what worked in the 1980’s will work today is just as flawed and insane as guys like Paul Krugman who sit back and tell us that the national debt is not a problem since we had a Debt to GDP ratio of 120% after WWII. Everything about this country and the global economy is much different today than it was in 1945 so Krugman should not be taken seriously on comments like that, just as Taylor and his rule should not be taken seriously since the country is in much different predicament than it was in 1980. Taylor starts out on the right foot by criticizing loose monetary policy, but never goes beyond that other than to conjure up his own medicine.
Overall though I am glad that the issue of extended periods of low interest rates is coming up in class which was my main point of sharing this with you.
Some thoughts after reading the Wiki on “Taylor Rule”.
He talks about a “desired rate of inflation”. So before you do his math, you have to sit down and decide “How much inflation do I want this year?” Meaning there is an assumption there that inflation is good. And yes it’s great for the US Govt, but very bad for US citizens. The govts interests and our interests are opposed. So that, even assuming the Taylor Rule is right, it is a mathematicizing of evil. Think Nazi scientists working on how best to gas the masses to death.
Also, to use the Taylor Rule, you need the magical ability to know “potential GDP”. There is a little hint about how to do this wizardry of knowing the unknowable: go with a “linear trend”. Meaning that if GDP was 4 last year, and 5 this year, then “of course” next year it’s going to be 6.
We can ignore the red lines. Let’s just see how accurate we would have been connecting the tops of the blue lines to each other in any two consecutive years to produce the next year’s GDP. Note how most years we would be dead wrong.
Then there is the question of how relevant GDP to anything related to economics. Let’s assume the govt taxed every last penny from every man woman and child [yes they tax children too], then borrowed money from China on top of that, and printed several trillion more dollars for good measure. They then built one giant airplane and filled it with all the resources in the USA, and dropped the plane in the middle of the sea, leaving us all penniless and starving with nothing to do about it, because all our resources are gone forever. That would be considered the most glorious economic success in the history of mankind, because GDP goes up when govt spending [on anything whatsoever and from whatever source] goes up. Our GDP would be cause for celebration; our actual economic situation cause for mourning. This is actually happening on a small scale, to the tune of a trillion dollars a year spent on war.
There are two vital numbers there, aπ and ay,which are vital to the equation, but for which there is no rule or reasoning whatsoever on what they should be. The best Taylor can do is give a “rule of thumb”, meaning a guess based on nothing at all, that they should be . Why? Because.
I mean this renders the whole thing ridiculous. Here we have an impressive looking equation, rivalling anything found in a math or Physics book:
“Wow. Really cool,” says the awestruck student. “You guys must be super scientific precise heroes, as good as engineers, using a formula like that with letters and all. BTW, how do you know what those a’s are?”
“We make it up.”
Also, the formula uses the GDP deflator, another little gem. I’m not 100% sure, but I think this is how the deflator works, according to Wiki: If the whole country can no longer afford fresh meat and has to start living on canned fish, but spends the same amount of money on that barely edible fish, there has been no inflation according to the GDP deflator. Please correct me if I’m wrong.
There is also an implicit assumption that it is the govt’s job to meddle in economic affairs. Why?
After all this castle in the air numbers crunching, he has the audacity to say that the formula should be used in the real world, where the lives and fortunes of billions of people are at stake.
Not only that, he wakes up and says “Hey guys. My formula tells me why there was a housing bubble. Sorry I didn’t mention that as the bubble was being blown up.”
“But the Austrians were predicting that bubble, for the same reason [low interest rates], based on theories developed decades ago. They scoff at your useless and pointless substitute for knowledge, and urge you to actually learn something.”
"Oh, those quacks? What do they know? Have they even taken a calculus course?
I’m guessing it’s a case of Emperor’s New Clothes.
Every once in a while, he seems to get things right. From the Wiki on him:
Taylor’s recent research has been on the financial crisis that began in 2007 and the world economic recession. He finds that the crisis was primarily caused by flawed macroeconomic policies from the U.S. government and other governments. Particularly, he focuses on the Federal Reserve which, under Alan Greenspan, a personal friend of Taylor, created “monetary excesses” in which interest rates were kept too low for too long, which then directly led to the housing boom in his opinion. He also believes that Freddie Mac and Fannie Mae spurred on the boom and that the crisis was misdiagnosed as a liquidity rather than a credit risk problem.[4] He wrote that
*"government actions and interventions, not any inherent failure or instability of the private economy, caused, prolonged, and worsened the [crisis](http://en.wikipedia.org/wiki/Late-2000s_recession)"[[5]](http://en.wikipedia.org/wiki/John_B._Taylor#cite_note-4)*
And his WSJ article has some good points as well. So maybe these guys are learning something.
Yes, he seems to get things right… but for the wrong reasons.
If I understand correctly he is not blaming the crisis in the institution of the Fed, but in mismanagement by the bureaucrats at the Fed. To me he seems to be saying that the problem is not that monetary central planning is a mistake, he is just saying that they did it wrong and to do it right they just need to follow his theory. And you have dissected his theory quite well.
But at the end of the day he is in favor of monetary central planning.
