When calibrating monetary policy, central bank officials often turn to the Taylor rule, a useful construct for thinking about the relationship between unemployment and inflation pioneered by John Taylor, former Treasury official and Stanford economics professor. So as the U.S. economy appears to falter and investors begin to speculate on the prospect of another round of monetary stimulus from the Federal Reserve, it’s worth checking in with Taylor’s model.
Economists at Goldman Sachs sought to do just that in a recent research note, and they found something interesting: if one accounts for the effects of unconventional easing through bond purchases as estimated by Fed Chairman Ben Bernanke, then policy is currently as accommodative as it needs to be.
To call for additional easing, these Taylor rules would need 1. much smaller estimates of the effectiveness of asset purchases than cited by Bernanke and/or 2. significant further deterioration in the Fed’s economic outlook.
Taylor himself has been critical of the Fed’s unconventional bond purchases, saying they are not very effective and may be riskier than they are worth.
However, Joseph Gagnon, a former Fed staffer now at the Peterson Institute for International Economics, argues that economists need to move away from abstract constructs and focus on reality, particularly during times of economic turmoil. Given a 9.2 percent jobless rate and low inflation, the Fed should be on doing more to support growth, said Gagnon in a telephone interview.