A Legislated Taylor Rule?

John Taylor announces in his blog post, "New Legislation Requires Fed to Adopt Policy Rule'' that today (June 8)

.. the ‘‘Federal Reserve Accountability and Transparency Act of 2014” was introduced into Congress. It requires that the Fed adopt a rules-based policy. Basically, the Fed would have to report to Congress and explain any deviation from a "Reference policy rule,"

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.

Wow. John will testify at a hearing at the House Financial Service Committee on Thursday, along with Mark Calabria, Hester Peirce and Simon Johnson. This should be very interesting.

Questions for discussion:


1. What is most interesting about a rule is what it leaves out. Notably absent here is "macroprudential" policy, "financial stability" goals, i.e. raising rates to prick perceived asset price "bubbles" and so forth. Janet Yellen's remarkable recent speech foreswore a lot of that.

Of course, the Fed could always add it as a "temporary" need to deviate from the rule. Still, many people might think that should be part of the rule not part of the exception. It also leaves out housing, exchange rates, and all the other things that central banks like to pay attention to.

A rule really is a list of things that the Fed shall not react to without explanation.

2. I will be interested to hear the debate between inflation targeters and rules advocates. Inflation targeting is a similar legislative approach, but it basically says "here is the goal. It is a very limited goal. Don't pay attention to anything else, and we won't blame you for anything else. Do whatever you want to get there." A rule prescribes the actions the Fed should take, with only limited statement about what the goal should be.

Inflation targeting is like "go to Minneapolis, not St. Louis, and don't get distracted by shopping along the way. The rest is up to you, wake me up when we're there." A rule is like "Stay on I-94. When the white line gets too close to the right wheels, turn a bit to the left; when the dashed line gets too close to the left wheels, turn a bit to the right. If you need to go to the bathroom, wake me up and tell me why we're getting off the freeway."

I am making too light of it, as these are serious issues. The point is to enhance the stability and predictability of monetary policy, to "anchor expectations," to help the Fed to precommit ex ante to actions it will be tempted to take ex-post, and to help the Treasury to precommit ex ante to provide the fiscal and legislattive support necessary to fight inflation or deflation -- an often overlooked issue -- and to precommit that Congress will not complain about the Fed if it follows the rule.

Rules vs. targets is a deep question that needs to consider political economy, expectations, game theory, and so forth.

3. Of course, if this goes anywhere we will have a big debate over what rule to enshrine in Federal legislation for a generation. Price level target or inflation rate target? Two? What about secular stagnation? Expected inflation or past inflation? Oh-Oh, here come the nominal GDP targeters. And the monetarists...

4. This only covers the short term Federal Funds rate, which may remain at zero for decades the way things are going. What about rules for asset purchases, macroprudential regulation, etc. etc.?