At the Hoover Institution’s 13th Monetary Policy Conference, prominent scholars looked at the legacy of the Taylor rule as they discussed how to get the economy back on track following a period of record inflation not experienced since the 1970s.
John Taylor — the George P. Shultz Senior Fellow in Economics at the Hoover Institution and a senior fellow at the Stanford Institute for Economic Policy Research (SIEPR) — is the economist behind the well-known rule that calibrates how a central bank changes interest rates in response to the inflation rate and the gap between actual and potential economic output.
The conference on May 12 was opened by the Hoover Institution’s director, Condoleezza Rice, who congratulated Taylor on the 30th anniversary of the monetary policy strategy he formulated to foster price stability and economic growth.
A session commemorating the Taylor rule was the first in a series of panel discussions at the daylong event featuring monetary and fiscal policy experts, including SIEPR senior fellows Taylor, John Cochrane, Anat Admati, Darrell Duffie, Amit Seru, and Joshua Rauh.
John Lipsky of Johns Hopkins University — a former deputy director of the International Monetary Fund and an advisory board member of SIEPR — reflected on the history and legacy of the Taylor rule, dating back to the time it was first presented at a conference at Carnegie Mellon University in 1993.
Put simply, the Taylor rule says that the Federal Reserve should raise the interest rate when inflation increases and lower the interest rate when gross domestic product (GDP) declines. The desired interest rate is one-and-a-half times the inflation rate, plus one-half times the gap between GDP and its potential, plus one.
Cochrane pointed out that before the Taylor rule, the universal doctrine of monetary policy was targeting money growth instead of interest rates. He also explained that the rule was never intended to be used mechanically (as if policy decisions were to be driven by a solution to an equation), but instead as a benchmark strategy that can predictably guide expectations.
The Taylor rule accurately predicted rates that helped foster economic prosperity in the 1990s (and in the 1980s when similar types of rules were applied). When central bankers abandoned the Taylor rule in favor of discretionary policy in the first decade of the 2000s, negative economic consequences followed.
In their presentations, Richard Clarida of Columbia University and Volker Weiland of Goethe University described how — coming out of the COVID-19 pandemic and the ensuing inflation surge — the Taylor rule can help get the economy back on track.
This story was adapted from an article originally published on May 24 by The Hoover Institution.