Muddle Over The Fed [Or How John Taylor Can’t Think Straight]

Today’s Financial Times has a couple of articles in it concerning the Federal Reserve Board and Ben Bernanke. The general thrust of each is to diffuse criticism of the Fed and to advocate it’s independence and the overall record of Bernanke himself. One piece is an editorial favoring Bernanke’s re-appointment as Fed chairman. The other is an op-ed by the well known economist John Taylor – he of the ‘Taylor Rule’ – arguing against expanding the Fed’s role as a regulator, and defending it’s role as ‘independent’ overseer of monetary policy.

It is this second piece that I want to address.

I was originally going to entitle this post something like: ‘John Taylor’s an Idiot’, but thought better of itbothout of deference to him, he has that rule named after him, and he teaches at Stanford, and because I didn’t think anyone reading my blog would know who he was.

Should you all care?

Yes: he is influential, and his views are a good reflection of the muddle that neo-classical economists can get themselves into when they want to defend their rotten theories from attack and, at the same time, deflect blame for the economic crisis away from those theories. Taylor often pops up with a right wing viewpoint, so he’s worth listening to in order to understand why our economic elite has so little to offer as we fumble our way out of the crisis.

So let’s get to his article.

He begins with a very ordinary argument against expanding the Fed’s powers as a regulator. I find myself in agreement with Taylor that the Fed should be highly limited. But when he slips into his patronizing justification that the government department’s are best forced to focus on limited objectives he let’s his orthodox slip show a tad too much. I get the feeling he’s thinking that those government employees are just too dumb to handle several tasks at once, unlike the heroes over at Citigroup, for instance. Hmmm. A bit of bias creeping in there Professor Taylor?

Then he goes on to argue for the Fed to be limited because extending its oversight remit would raise the risk – gasp – of political interference. And in neo-classical ideology nothing – and I mean nothing – can be worse than political interference. this is because we all absolutely ‘know’ that the government is always inefficient when compared with the smooth operation of the free market – right Professor Taylor?

So we want to remove politics from the Fed so as to sanitize it from the taint of government. That way it can take those hard decisions raise interest rates and prevent bubbles without having to worry about what the politicians think, or what would happen to those big banks it regulates.

Taylor is right: a Fed that has big ‘systemically important’ banks as it regulatory target might be more inclined to do things to help those banks avoid trouble – after all it will know what kind of mess they are in and it wouldn’t want to be blamed if one went belly up.

But this raises a conundrum for Taylor and all ideologues like him:

If the Fed is independent of government and thus making decisions based upon purely economic grounds – informed by standard economic theory no less – how do we all account for its recent performance?

Taylor does this by eliding straight into an attack on government.

The second part of his article talks about how the current crisis stems from a failure of government. He puts it succinctly::

“The financial crisis was caused in large part by government actions such as monetary authority that aggravated the housing boom.”

Let’s think this through rigorously rather than sloppily.

The housing boom was, according to Professor Taylor, abetted by lax government actions. Ergo to avoid future recurrences we need to slap government into shape rather tan extend its role by giving the Fed more oversight.

But Professor: is the Fed not independent of the government? Is it not your fear that the Fed might lose that independence? Have you not just spent half an article arguing that extending the Fed’s role would jeopardize that independence?

I think the Professor has his proverbials in a twist.

He has run plumb into the neo-classicists ideological trap.

Yes the Fed is proudly independent. Yes it would lose that independence were it to take on more regulatory responsibility. That is why I want to strip it of all regulatory responsibility.

But that’s the point Professor: it is and was independent. It has been since 1951, when as the Financial Times editorial points out the heavy hand of Treasury [i.e. government] meddling was cut away.

So: it was not ‘government actions’ that contributed to the financial crisis, was it? No not at all. It was the independent Fed under the leadership of Alan Greenspan and Ben Bernanke.

There you have it.

Taylor is playing the usual right-wing bait and switch game.

He is saying the Fed should remain independent because that suits his anti-government bias. But then he turns around and blames the government for the financial crisis. And the government agency he pins the blame on is the same Fed whose independence he lauded but two sentences previously.

Now the Professor is academically very rigorous no doubt – tainted by his ideology, but so are most academic economists – but he allows himself to be extraordinarily sloppy in this article. He surely wouldn’t give himself a very good grade.

So why does he commit his error?

Because there is something even more sinister than government interference in his mind: criticism of orthodox economic theory.

It turns out that the independent Fed executed flawlessly along the lines expected by textbook theory. And thereby contributed mightily to the crisis.

So the good Professor is trapped into defending the Fed as independent when it works well, and then contradicting himself and labeling it as a government agency when it screws up.

How rigorous!

How non-scientific!

How totally political!

How ideological!

That’s textbook economics for you.

No wonder economists are the subject of ridicule.

A true scientist -something Taylor evidently is not – would look at the evidence and reformulate his hypothesis in the light of revealed facts. Not those neo-classicists! No. They reformulate the facts in order to preserve their hallowed theories.

Elsewhere in the FT another columnist – Tony Jackson – calls out the neo-classicists. He relates the story of Robert Schiller – a renegade in economics – getting a cold reception at an economics seminar when he used the word ‘bubble’. Schiller says that word was received like talk of zodiac signs at a meeting of astronomers. For those of you who don’t realize it: there can be no bubbles in a neo-classical world. The market is always correct in its valuations no matter how erratic or absurd.

It is that level of denial that allows Taylor to double talk in his article.

Back on planet earth, and away from the world Taylor and his ilk inhabit, it is the neo-classicists who are the astrologers.

Ben Bernanke as palm reader-in-chief. Now that has a ring to it.

Addendum:

More bad news for the Professor. Here’s a quote from the Wikipedia entry that describes the ‘Taylor Rule’ – a piece of economic thinking that the Professor is no doubt proud of:

“Although the Fed does not explicitly follow the rule, many analyses show that the rule does a fairly accurate job of describing how US monetary policy actually was conducted earlier under Alan Greenspan“

Hmmmm.

The Fed clearly followed the Taylor Rule during the Greenspan era. Right when the Professor claims that the Fed, qua government agency, was contributing to the financial crisis.

Now we’ve got him.

Apparently it was the Taylor Rule that contributed to the financial crisis.

Ouch!

That’s got to hurt.

No wonder he’s muddled about the Fed. They use his rule, and drive the ship onto the rocks. Oops. No wonder he’s angry at them.

Maybe it’s a different Taylor?

Nope. Sorry Professor: you’re part of the problem.