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Unformatted text preview: 6 Finance & Development March 2008 6 Finance & Development March 2008 H AVING a concept named after you is as much a mark of honor in economics as it is in other sci- ences. By this standard, Stanford’s John Taylor is among the most honored macroeconomists of his generation. Indeed, concepts bearing his name have become so pervasive that U.S. Federal Reserve Board Chair- man Ben Bernanke joked that “with our appetites whetted by the Taylor rule, the [Taylor] principle, and the [Taylor] curve, we now look forward to the Taylor dictum, the Tay- lor hyperbola, and maybe even the Taylor conundrum.” The best known of these concepts, the Taylor rule, is a simple equation that Taylor propounded in 1992 to describe the response of the Fed’s interest rate target to inflation and business cycles. The equa- tion succeeded as both description and prescription: it described how the Fed had been setting its interest rate target and prescribed what the Fed ought to—and might—do next. The equation quickly gained wide acceptance among central banks as a useful guide for policy. Those who know John Taylor well are not surprised at this success. At a conference held in Dallas last year to honor Taylor’s work, the IMF’s First Deputy Managing Director, John Lipsky, a graduate school classmate of Taylor’s, said: “If there had been a yearbook of our Ph.D. cohort at Stanford, the caption beneath John’s picture might well have stated: ‘Most Likely to Develop a Successful Monetary Policy Rule.’ His interests and training surely pointed toward such a con- tribution.” The academic work laid the foundation, Taylor agrees, but what “made it all gel” was his policy experience in Washington during two stints at the U.S. Council of Economic Advisers (CEA), he tells F&D . “I doubt I would have had that idea without the CEA experience.” Indeed, Taylor’s career has been marked by an easy back-and-forth between academia and policymaking, most recently as the U.S. Treasury’s top official for international affairs. When in academia, he jumps into teaching and research with an abandon that seems uncharacteristic of a Washington policymaker: to grab students’ attention in a class on agricultural supply and demand, he once pranced around the classroom in a California raisin costume to the tune of Marvin Gaye’s “I Heard It Through the Grapevine.” The Quest for Rules PEOPLE IN ECONOMICS Prakash Loungani interviews John Taylor From discretion to rules Until the 1970s, the workings of the Fed and other central banks were shrouded in mystery. Monetary policy was con- sidered an esoteric topic best left to the discretion of techni- cians. The problem was that this use of discretion often led to costly mistakes: for example, during the Great Depression, when the Fed sent the economy into a tailspin by stepping on the brakes instead of the accelerator, or during the Great Inflation of the 1970s, when the Fed let inflation ratchet up to double digits.to double digits....
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