Choose Economic Freedom by George P. Shultz & John B. Taylor

Author:George P. Shultz & John B. Taylor
Language: eng
Format: epub
Tags: economics, economic policy, public policy, economic guidelines, wage controls, price controls, free market, inflation, government, Richard Nixon, Ronald Reagan, Robert Solow, Arthur Burns, Chicago School, Nixon Shock, Federal Reserve
Publisher: Hoover Institution Press
Published: 2020-02-29T16:00:00+00:00

CHART 5. FEDERAL FUNDS RATE VS. TAYLOR RULE. We can use the Taylor rule to illustrate comments made by Milton Friedman about monetary policy choices made in the 1970s versus the 1980s. (For more information about the Taylor rule, see appendix D.)

The graph shows what the interest rate would have been under the Taylor rule along with the actual interest rate, the federal funds rate. The data are “real time,” or what was available to the Fed at the time.

The deviation between the actual rate and the rule is plotted in the lower part of the graph. The deviation is large and negative in the 1970s, especially in the late 1970s. Inflation was high and variable, and output fluctuations were large during this period.

Policy then changed. A positive deviation in the early 1980s was as large as the negative deviation in the 1970s, but this was the transition to a new policy. During the transition—a period of disinflation—the interest rate went above the rule as the Fed brought inflation down. Following this transition, there were nearly two decades during which there was virtually no deviation. Economic performance was very good during this period.

Source: John H. Cochrane, John B. Taylor, and Volker Wieland, “Evaluating Rules in the Fed’s Report and Measuring Discretion” (discussion paper prepared for presentation, Strategies for Monetary Policy conference, Hoover Institution, Stanford, CA, May 3, 2019). Based on Alex Nikolsko-Rzhevskyy, David H. Papell, and Ruxandra Prodan, “Policy Rules and Economic Performance” (white paper, December 11, 2018).

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