Wednesday, April 4, 2018

Salerno Blasts the Taylor Rule

During an extensive interview with Mises Institute President Jeff Deist, Joseph Salerno offered a powerful, and justified, critique of the Taylor Rule. The Rule has gained supporters amongst part of the economic community as a method for central banks to control money supply. Indeed, in recent testimony before Congress, Fed chairman Jay Powell appeared to give a nod to monetary rule.

Here Salerno on the Rule:
John Taylor has taken credit for the fact that his rule indicated that money was too loose from 2001 to 2005, that with his rule, there would have been a much higher interest rate that would possibly have prevented the real estate and financial bubbles and subsequent financial crisis.

And that may be true, if you look at the interest rate generated by his rule compared to the actual interest rate. If we go back to the late 90s, from about ’95 to ’99, we find his rule indicating the interest rate should be lower than it actually was and yet, the US economy experienced the dot-com bubble during that time. So, his rule would have exacerbated the tech bubble and he never talks about that. His rule also depends on arbitrary coefficients that have to be inserted into his equation. Lastly, the Taylor rule is a recipe for the Fed to manipulate the interest rate, which Austrians vigorously oppose. The interest rate is set on the market by people’s time preferences, by the preferences of people who want to abstain from present consumption and save and invest money in the structure of production, the production of capital goods that will yield consumer goods in the future.

-Robert Wenzel 

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