John Taylor is out with new paper on “The Effectiveness of Central Bank Independence Versus Policy Rules”.

Here is the abstract:

“This paper assesses the relative effectiveness of central bank independence versus policy rules for the policy instruments in bringing about good economic performance. It examines historical changes in (1) macroeconomic performance, (2) the adherence to rules-based monetary policy, and (3) the degree of central bank independence. Macroeconomic performance is defined in terms of both price stability and output stability. Factors other than monetary policy rules are examined. Both de jure and de facto central bank independence at the Fed are considered. The main finding is that changes in macroeconomic performance during the past half century were closely associated with changes the adherence to rules-based monetary policy and in the degree of de facto monetary independence at the Fed. But changes in economic performance were not associated with changes in de jure central bank independence. Formal central bank independence alone has not generated good monetary policy outcomes. A rules-based framework is essential.”

So far I have only run thought very fast, but it looks very interesting and I certainly do agree with the main conclusion that the important thing is a rule-based monetary framework rather than central bank independence. Taylor obviously prefers his own Taylor rule – Market Monetarists including myself prefer NGDP level targeting. Nonetheless getting central banks to follow a rule based monetary policy must be the key objective for monetary policy pundits. That is the view of John Taylor and Market Monetarists alike.

Here is another very interesting paper – “The Influence of the Taylor rule on US monetary policy” – certainly related to Taylor and the Taylor rule.

Here is the abstract:

“We analyze the influence of the Taylor rule on US monetary policy by estimating the policy preferences of the Fed within a DSGE framework. The policy preferences are represented by a standard loss function, extended with a term that represents the degree of reluctance to letting the interest rate deviate from the Taylor rule. The empirical support for the presence of a Taylor rule term in the policy preferences is strong and robust to alternative specifications of the loss function. Analyzing the Fed’s monetary policy in the period 2001-2006, we find no support for a decreased weight on the Taylor rule, contrary to what has been argued in the literature. The large deviations from the Taylor rule in this period are due to large, negative demand-side shocks, and represent optimal deviations for a given weight on the Taylor rule.”

John Taylor has long argued have long argued that the present crisis was a result of the Federal Reserve diverging from the Taylor rule in years just prior to 2008 and that caused a boom-bust in the UK economy. The aforementioned paper by Pelin Ilbas, Øistein Røisland and Tommy Sveen indicate that John Taylor is wrong on that view.

So concluding, John Taylor is right that we need a rule based monetary policy framework, but he is wrong about what rule we need.

HT Jens Pedersen

PS I still find Taylor’s focus on interest rates as a monetary policy instrument both frustrating and very wrong. It might have been the biggest problem with the Taylor rule – that central bankers have been led to think that “the” interest rate is the only instrument at their disposal.