The father of the Taylor Rule: a defence of rules at WES 2018

John B. Taylor’s speech at the Warwick Economics Summit offered meaningful insight into the challenges that continue to face monetary policymakers all over the world.Taylor is currently Mary and Robert Raymond Professor of Economics at Stanford University, and is best known for his seminal contribution to monetary economics, the Taylor rule. Given Taylor’s longstanding distinguished status in the field of monetary economics, it is essential that future leaders of the world economy heed his advice.

The primary virtue of such rule-based frameworks, including the original Taylor rule was their simplicity…

Professor Taylor pointed to the somewhat neglected importance of policy rules, what Taylor called the ‘rule-space’ in central banks’ decision making. The primary virtue of such rule-based frameworks, including the original Taylor rule was their simplicity – they looked at the state of the economy and told central banks how their policy instruments should be adjusted to meet their targets. In layman’s terms, policy rules generally determined the optimal interest rate to be set given the prevailing level of GDP and inflation.

‘Deviating from rule-based policy has a cost’ – the new policy approach increased the volatility of key economic indicators…

What’s most important, he emphasised, is that the rule-space worked. Starting from the 1980s, central banks all over the world adopted transparent rule-based policies, leading to a dramatic improvement in economic outcomes. The resulting period of stability came to be known as the ‘Great Moderation’, or as it was more creatively named by Lord Mervyn King, who spoke earlier at the Summit, ‘NICE’ (non-inflationary consistently expansionary).

Since the early 2000s there has been a tendency to set interest rates significantly lower than suggested by policy rules. However, as Taylor emphasised, “deviating from rule-based policy has a cost” – the new policy approach increased the volatility of key economic indicators, and also contributed to the global financial crisis of 2008 by prompting investors to take too much risk. Long story short, in contrast with NICE, the abandonment of policy rules led to a “very bad period”.

The international coordination of these rules would be another major step in the right direction…

Taylor concluded that there is an indispensable need for central banks to return to rules-based policies. In particular, he called for the establishment of “an interface between researchers and policymakers”, based on robust policy rules that integrate the novel analytical findings of the post-crisis era. He also proposes that the international coordination of these rules would be another major step in the right direction.