Book review: Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis, by John B. Taylor.
This book contains a few good ideas, expressed simply and clearly. It explains some of what caused the 2008 financial crisis. But he exaggerates a good deal when he claims he has “provided empirical proof that monetary policy was a key cause of the boom”.
He provides clear evidence that counterparty risk was a more important problem than lack of liquidity, and has some hints about how counterparty risk could have been handled better. But that doesn’t say much about whether policies to deal with liquidity problems were mistaken – I doubt that many of the people pushing those liquidity related policies were denying that counterparty risk was a problem.
I’ve been convinced since before the crisis that having the Fed follow the Taylor Rule would have been better than the monetary policy that we actually had. But the details of the rule seem somewhat arbitrary, and I’m disappointed that the book doesn’t provide much explanation of why the Taylor Rule is better than alternative rules.
I’ve found a link on Taylor’s blog to an article (The Taylor Rule and QE2 By David Papell) which compares it to some alternatives which seem motivated primarily by a desire to rationalize more monetary or fiscal stimulus. But what I want to know is whether it’s possible to create a rule that is more countercyclical without being more inflationary.
I have an intuition that it’s not too hard to improve on the inflation component of the rule. The CPI seems to have many drawbacks, such as being slow to reflect changes. I suspect Taylor’s inflation coefficient of 1.5 is larger than what an ideal rule would use in order to make up for the delays associated with using the CPI. When I’m estimating inflation for my investment decisions, I pay more attention to the ISM price index, the money supply (MZM), commodity prices, and stock prices. And the ISM Purchasing Managers Index should provide more up to date evidence of the “output gap” than GDP figures. A version of the Taylor Rule which emphasized those should react more quickly to changes in the economy.