I heard John Taylor, a respected Macroeconomist with an extensive academic research record and lots of actual public policy experience, speak on Friday. The full text of Professor Taylor’s speech is here.
Flanked by a large number of distinguished economists, he spoke about monetary and fiscal policy, making a distinction between rules-based policy and discretion-based policy. Mr. Taylor pointed out that during the 1960s and 1970s, policies tended to be discretionary rather than rules-based, and the economy suffered as a result. During the 1980s and 1990s, policies tended to be rules-based rather than discretion-based. Recently, since about 2008, policies have switched back to discretion, and the economy is not doing well by any measure. He pointed out that politics do not appear to matter in these policy regimes because both regimes have operated under both conservative as well as liberal governments.
What is a rules-based policy environment? This is where policy follows a publicly pre-announced formula and policy actions are only taken when consistent with the formula. A monetary example: the Fed announces that they will only raise interest rates if inflation exceeds 2 percent. If they broke the rule, for example raising interest rates when inflation was 1.5 percent, then this would be considered discretionary policy. It is a policy outside the pre-announced rule.
We should consider Professor Taylor’s advice.