John Taylor writes, apropos of his demand that the Federal Reserve get on track to reduce its balance sheet to normal as soon as practicable:
I warned… in September 2010 about the dangers of "another large dose of quantitative easing" that would raise "more uncertainty about how it will ever be unwound"…
My concerns have been about a two-sided risk, with downside effects on the economy due to the uncertainty about the exit, the distortions of financial markets (including the Fed replacing several large markets with itself), the international repercussions which feed back on the U.S. economy, and other unintended consequences. Unfortunately, those downside risks have panned out with a terrible economic recovery to show for it.
Is Taylor really saying that real GDP growth would have been faster over the past 2.5 years with no QE and higher long-term interest rates? How? Through what channels?
What is his model of the economy?
I really see no method at all here…
But it has been a long time since I saw any method to what John Taylor writes for the Wall Street Journal.
Let's take a look, starting in 2010:
- John Taylor (January 11, 2010): "You do not have to rely on the Taylor rule to see that monetary policy [in 2004-5] was too loose. The real interest rate during this period was persistently less than zero…. Inflation was increasing, even excluding skyrocketing housing prices."
Say what? Inflation was increasing in 2004-5? By de minimis amounts, if at all--not a visible sign in wages or prices that monetary policy was in any sense too loose:
- John Taylor (May 3, 2010): "Some say that the government did not have enough power to intervene with certain firms during the financial crisis. But it had plenty of power and it used it, beginning with Bear Stearns. This highly discretionary power… was a major cause of the financial panic in the fall of 2008. The broad justification used for the bailout of Bear Stearns creditors led many to believe the government would again intervene if another similar institution, such as Lehman Brothers, failed. But when the Federal Reserve and the Treasury Department could not persuade private firms to provide funds to Lehman to pay its creditors in September 2008, the Fed surprisingly cut off access to its funds. The examiner's report on Lehman makes it very clear there was no preparation for bankruptcy proceedings before the day the government suddenly cut off the funds. No wonder there was a disruption."
The "some" say that the fact that the government did not have the power to lend to or take over an insolvent investment bank like Lehman Brothers in September 2008 was destructive. Taylor says that that was false: that the government had plenty of power, as shown by its lending to the solvent universal bank of JPMC during the Bear Stearns crisis, and what was destructive was the failure of the government to take over or the Fed to keep lending to the insolvent Lehman.
- John Taylor (July 1, 2010): "The bill creates a new resolution, or 'orderly liquidation', authority in which the Federal Deposit Insurance Corporation (FDIC) can intervene between any complex financial institution and its creditors in any way it wants to. Effectively the bill institutionalizes the harmful bailout process by giving the government more discretionary power to intervene. The FDIC does not have the capability to take over large, complex financial institutions without causing disruption, so such firms and their creditors are likely to be bailed out again."
It is as if Taylor has forgotten that two months before he had written that it was the failure of the Federal Reserve to lend to Lehman in September 2008 that was the problem.
- John Taylor (September 9, 2010): "[The Federal Reserve should] announce and follow a clear exit rule, in which the Fed's bloated balance sheet is gradually pared back by predictable amounts as the economic recovery picks up. Such a policy would be a much better stimulus than another large dose of quantitative easing in which the Fed's balance sheet explodes even further, raising more uncertainty about how it will ever be unwound."
In every economic model in which I am aware of, you know when the government is creating uncertainty and risk because people demand to be compensated for bearing that risk, and so asset prices fall. Is Taylor really claiming that stock prices and bond prices would have been lower since September 2010 if the Fed had returned its balance sheet to its normal $700 billion starting in the fall of 2010? That's the only interpretation I can give this.
- George Shultz, Michael Boskin, John Cogan, Allan Meltzer, and John Taylor (September 16, 2010): "The departures from sound principles continued when the Fed and the Treasury responded with arbitrary and unpredictable bailouts of banks, auto companies and financial institutions. They financed their actions with unprecedented money creation and massive issuance of debt. These frantic moves spooked already turbulent markets and led to the financial panic."
This is just embarrassing: the claim is that knowledge that the Obama administration was going to provide bridge financing for Chrysler and GM and that the Fed was going to nationalize AIG traveled backward in time and caused the panic that brought down Lehman Brothers. The best you can say about this is that a bunch of different authors were trying to say different things and nobody did a final edit for intellectual coherence.
- John Taylor and 22 others (November 15, 2010): "The planned [Federal Reserve] asset purchases risk currency debasement and inflation."
How has that prediction turned out for Taylor?
- John F. Cogan and John B. Taylor (December 9, 2010): "The Obama Stimulus Impact? Zero…. Of the $862 billion stimulus package, the change in government purchases at the federal level has, thus far, been extremely small. From the first quarter of 2009 through the third quarter of 2010, government purchases have increased by only 3% of the $862 billion…. In a $14 trillion economy, these amounts are immaterial…. The bottom-line is the federal government borrowed funds from the public, transferred these funds to state and local governments, who then used the funds mainly to reduce borrowing from the public. The net impact on aggregate economic activity is zero, regardless of the magnitude of the government purchases multiplier."
Say what? At annual rates:
- John Taylor (January 28, 2011): "The Fed should lay out a plan for reducing its extraordinarily large balance sheet…. The Fed's objectives should be clarified. The Federal Reserve Act now says the Fed must "promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." But too many goals blur responsibility…. Recently the multiple objectives have been used as a rationale for interventionist policies, such as QE2, an approach that Fed officials avoided in the 1980s and '90s. Such interventions can have the unintended consequence of increasing unemployment--as illustrated by the decisions to hold interest rates very low in 2003-2005, which may have caused a bubble and led to the high unemployment today."
Does Taylor really believe unemployment would have been lower in the past three years if the Fed had had the single price-stability mandate of the ECB? On what evidence?
- Gary Becker, George Shultz, and John Taylor (April 4, 2011): "Wanted: A strategy for economic growth, full employment, and deficit reduction--all without inflation…. Higher government spending is not associated with lower unemployment. For example, when government purchases of goods and services came down as a share of GDP in the 1990s, unemployment didn't rise."
This is just embarrassing. When government purchases came down in the 1990s, unemployment did not rise because the Federal Reserve lowered interest rates to keep unemployment from rising. The big problem today is that the Federal Reserve has no traction to lower interest rates further.
- John Taylor (April 22, 2011): "Obama's Permanent Spending Binge…. Most obvious is the huge bulge in spending in the past few years. In 2000 spending was 18.2% of GDP. In 2007 it was 19.6%. But in the three years since 2009 it's jumped to an average of 24.4%…. When I show people this chart they ask why Washington is even having the debate. They say: If government agencies and programs functioned with 19% to 20% of GDP in 2007, why is it so hard for them to function with that percentage in 2021, when GDP will be substantially higher and with many opportunities for reforms and increased efficiencies?"
This, if possible, makes me wince even more. Forecast spending is higher as a share of GDP in 2021 because our population is aging and because medical care is getting more expensive. Full stop.
- Dan Kessler and John Taylor (August 17, 2011): "A study by Medicare Payment Advisory Commission (MedPAC) researchers published in the 2008 Health Affairs suggests that Medicare's overpayment for imaging services contributed to rapid spending growth. Although the new health-reform law seeks to address this problem with the IPAB, there is little reason to believe that it will succeed substantially better than MedPAC, which was created in 1997 in part to insulate Medicare policy from political meddling."
There is every reason to believe that IPAB will succeed substantially better than MedPAC. IPAB's recommendations go into effect automatically. MedPAC's required Republican congressional leaders to move a bill to enact its recommendations--which they never did.
- John Cogan and John Taylor (October 4, 2011): "In response to the recession that began in late 2007, both Presidents Bush and Obama chose to rely on Keynesian stimulus policies…. Mr. Obama's $800 billion temporary, targeted stimulus plan took the same approach as Mr. Carter's more than three decades earlier. The February 2009 bill included temporary tax rebates, additional spending on federal programs, and one-time grants to state and local governments. It had the same negligible economic impact as Mr. Carter's…. That temporary tax reductions and increases in government spending can jump-start the economy and sustainably boost employment and personal income may seem like a politician's dream policy. But the repeated failure of these short-term interventionist policies to deliver the promised economic benefits should make politicians think twice. Reliance on them has already cost dozens of members of Congress their jobs and two postwar presidents a second term."
Say what? The evidence is that fiscal expansion has been somewhat stronger in boosting economies since 2007 than most economists (including me) expected before the financial crisis. For example, Blanchard and Leigh:
- John Taylor (November 1, 2011): "Some countries, including Mexico and Brazil, are complaining that the Fed is exporting inflation with its near-zero interest rate and massive purchases of long-term government debt, which is rapidly growing due to U.S. fiscal deficits. And when global inflation picks up, as it has started to do in many emerging markets, it feeds back into more inflation in the U.S. through higher prices of globally traded commodities. With unemployment already high, the result would be stagflation—slow growth, high inflation, steady unemployment—as we saw in the 1970s."
Yes, Taylor made yet another forecast of imminent inflation in November 2011…
- John Taylor (December 21, 2011): "The two-month payroll tax cut being debated in Washington reduces to the absurd the recent revival of short-term Keynesian stimulus programs. That such a temporary cut would stimulate the recovery and get employment growing defies common sense. There is no hard evidence that the temporary payroll tax cut of this year stimulated the economy…. Even economists who claim that these policies stimulate—such as those at forecasting firm Macroeconomic Advisers—admit that they cost jobs as they are turned off, leaving the recovery no better off."
But Macro Advisers says that the people are better off: between the moment the tax cut was turned on and the moment it was turned off, more people had jobs and earned income and were able to purchase commodities. It is not the case that such a payroll tax cut in a depressed economy makes people "no better off".
- John Taylor (January 25, 2012): "Reagan gave innumerable radio addresses putting forth his principles. He used down-home stories of economic freedom that he could tell in three minutes or less. There were no ghost writers—he wrote his stories in long hand on lined yellow paper as he traveled around the country."
Is John Taylor really claiming that Ronald Reagan had no speechwriters?
- John Taylor (February 22, 2012): "In my view, fears of contagion [from Greece] were exaggerated in the first place--as they always are by people who stand to benefit from bailouts or lose from write-downs. These fears led top officials in Europe to try to avoid the inevitable restructuring. But contagion is unlikely if policy is predictable. International contagion was negligible following the anticipated Argentine default in 2001, in comparison with the surprise Russian default in 1998."
Say what? International contagion was negligible following the anticipated Argentine default in 2001 because no other countries were seen as at all analogous to Argentina. Greece is but one of a number of peripheral European countries. It is extremely rash to claim no possibility of contagion from Greece to Portugal or Spain.
- John Taylor (March 29, 2012): "Now, with inflation and the economy picking up, the Fed is again veering into "too low for too long" territory. Policy indicators suggest the need for higher interest rates, while the Fed signals a zero rate through 2014."
I can't stand it. March 2012. "Inflation picking up." "Policy indicators suggest the need for higher interest rates."
- John Taylor (January 29, 2013): "If investors are told by the Fed that the short-term rate is going to be close to zero in the future, then they will bid down the yield on the long-term bond…. Effectively the Fed is imposing an interest-rate ceiling on the longer-term market by saying it will keep the short rate unusually low…. This is much like the effect of a price ceiling in a rental market where landlords reduce the supply of rental housing. Here lenders supply less credit at the lower rate. The decline in credit availability reduces aggregate demand, which tends to increase unemployment, a classic unintended consequence of the policy."
I can't stand it. A rent-control price ceiling is when the government forbids landlords to rent at above the ceiling: that is a first-order distortion that causes allocative inefficiency because it keeps private agents from making deals they both want to make. The Federal Reserve's statement that it will buy bonds in the future if their prices would otherwise decline does not keep private agents from making deals they both want to make. IT'S A DIFFERENT THING!!! IT BLOCKS NO WIN-WIN PRIVATE DEALS!!! IT CAUSES NO ALLOCATIVE INEFFICIENCIES!!!
- John Cogan and John Taylor (March 19, 2013): "This week the House of Representatives will vote on its Budget Committee plan…. The plan has been denounced by naysayers who assert that it would harm the economic recovery…. According to our research, the spending restraint and balanced-budget parts of the House Budget Committee plan would boost the economy immediately. With the Budget Committee's proposed tax reform included, the immediate impact would be even larger. The entire plan would raise gross domestic product by one percentage point in 2014…. Ten years from now, at the end of the official budget horizon, we estimate that the entire plan would raise GDP by three percentage points, or more than $4,000 for each U.S. household. Our assessment is based on a modern macroeconomic model (developed with Volker Wieland of the University of Frankfurt and Maik Wolters of the University of Kiel) whose features include a recognition that the resources to finance government expenditures aren't free--they withdraw resources from the private economy."
Breath. In, out, in, out.
May I simply say that a model that assumes that the economy will be at full employment in 2014--that increasing government purchases soaks up resources that would otherwise be used to produce goods to satisfy private demands--is simply not a good model to use in analyzing today's depressed economy?
- George Shultz, Gary Becker, Michael Boskin, John Cogan, Allan Meltzer and John Taylor (March 25, 2013): "Washington has become a city of tactics, obsessed with finger pointing, fear mongering and political spin…. The country needs a long-term strategy to achieve its common goals of personal freedom, noninflationary prosperity, broad-based economic opportunity and mobility, and national security. With a good strategy as a foundation, sound economic policies will follow…. The obvious place to begin applying strategic thinking is to the budget--the primary vehicle for setting priorities. Yet, in recent years, the budget process has completely broken down, replaced by disorderly management by crisis. This year the president has thus far failed to produce a budget. We need to go back to an old-fashioned regular budget order. The president needs to submit a budget that contains a strategic plan and brings the budget into balance. The House and Senate then need to pass a budget resolution…. Appropriations legislation should focus on the coming fiscal year and the next, not on 10-year multitrillion-dollar totals that the current Congress can't control and the public can't understand."
Breath. In, out, in, out.
Was it really just a week earlier that Taylor and Cogan had been boasting about how their (faulty) model predicted enormous gains to the economy now from adopting one of those plans with the 10-year multitrillion-dollar totals?
- Kenneth Scott and John Taylor (May 15, 2013): "Title II of Dodd-Frank established… the Orderly Liquidation Authority. The Federal Deposit Insurance Corporation has the authority to 'resolve' a large financial firm when it fails. Consistent with the original rallying cry for the legislation, it will 'wipe out' shareholders…. The FDIC will transfer a selected part of the firm's assets and liabilities to a new 'bridge' institution, with more discretion and less transparency and judicial oversight than in bankruptcy. Some creditors' claims can receive larger payments than under a typical bankruptcy--effectively a bailout--in the name of avoiding systemic consequences…. There is a better way…. A Chapter 14 would apply to all financial groups with assets over $100 billion. A specialized panel of judges and court-appointed special masters with financial expertise would oversee the proceeding…. There would be judicial hearings and creditor participation…. The strict priority rules of bankruptcy would govern (with some modifications for holders of repurchase agreements and swaps to limit their risks)…. Customers would continue to do business with a financial firm after a Chapter 14 filing if they were confident the firm could meet its current obligations. That confidence would be achieved by giving post-petition creditors a high priority. In all likelihood, this priority would enable the firm to continue obtaining ample private financing--so-called debtor-in-possession financing--to provide liquidity for normal operations."
Breath. In, out, in, out.
So now Taylor (a) doesn't like the Dodd-Frank resolution mechanism and wants to replace it with another one, and (b) stresses the importance of the availability of debtor-in-possession financing that he denounced the Obama administration for providing to GM and Chrysler when he wrote back on September 16, 2010.
And we finally arrive back at now:
- John Taylor (July 11, 2013): "Fed Chairman Ben Bernanke let it be known in a news conference that the old QE3 (purchasing $85 billion of Treasury bonds and mortgage-backed securities a month until labor market conditions improve substantially) would taper into a new QE3—in which purchases would likely slow by the end of 2013 and stop in the middle of 2014. The turbulent reaction in the markets showed that the predicted dangers from unwinding would be real."
As I read this, Taylor is saying: interest rose--a bad thing--when Bernanke indicated that the Fed might stop QE late this year, so it is important to stop QE much faster than Bernanke plans. But why? So that interest rates can rise even more? But wouldn't that be a worse thing?