Tuesday, January 5, 2010

Taylor swiftly rebukes Bernanke

I had a good seat on Sunday for Fed Chairman Ben Bernanke's defense of the Fed's monetary policy from 2000 on. Bernanke was attempting to refute the arguments that monetary policy following the 2001 recession was too easy and that it helped to inflate the housing bubble.

In his speech, Bernanke compared the Fed's federal funds targets over the period to the Taylor Rule, a guideline developed by Stanford economist, John Taylor, that describes how interest rates should respond to deviations of inflation and output from target levels.

Bernanke showed that if standard, contemporaneous measures of inflation and output were included in the formula for the rule, Fed policy did appear to be too easy. However, he argued that those measures were not appropriate--a different measure of inflation should be used and that forecasts of the input values should be used rather than contemporaneous measures. When these measures were substituted, the Fed's policies appeared to be much closer to the Taylor rule.

In an interview today, however, Taylor called shenanigans on Bernanke.
John Taylor, creator of the so-called Taylor rule for guiding monetary policy, disputed Federal Reserve Chairman Ben S. Bernanke’s argument that low interest rates didn’t cause the U.S. housing bubble.

"The evidence is overwhelming that those low interest rates were not only unusually low but they logically were a factor in the housing boom and therefore ultimately the bust," Taylor, a Stanford University economist, said in an interview today in Atlanta.
But, hey, what would Taylor know about his own rule.