It is understandable that economists would like things that bear their name to survive. Examples are “Beveridge Curve” and “Okun Law” among many others (“Nash Equilibrium”, for example).

So it´s not surprising to see John Taylor trying hard to ‘enshrine’ his namesake rule: The “Taylor-Rule” for setting interest rates by the Fed:

A lot of research and experience shows that more predictable rules-based monetary policy leads to better economic performance—both in terms of price stability and steadier-stronger employment and output growth. But in practice there have been big swings in Fed policy between rules and discretion, with damaging results as in the 1970s and the past decade of a financial crisis, great recession and slow recovery. This experience—especially the swing from rules to discretion in the past decade—demonstrates the need for legislation requiring the Fed to adopt rules for setting its policy instruments. So it is good news that today the ‘‘Federal Reserve Accountability and Transparency Act of 2014” was introduced into Congress. It requires that the Fed adopt a rules-based policy.

But it´s not so ‘simple’. As Nick Rowe reminds us:

A “simple rule” is a formula that tells a central bank how to set the nominal interest rate as a fixed function of a small number of variables. The Taylor Rule, which sets the nominal rate as a function of the gap between actual and target inflation, and the gap between actual and potential output, is the classic example of a simple rule. Are simple rules better than discretion? Here’s how we can do a test to find out, and the results of an old test where simple rules failed to do better than actual policy. We need to distinguish between “instrument rules” and “target rules”. The Bank of Canada, for example, sets a nominal interest rate instrument to target 2% inflation. The Bank of Canada follows a very simple target rule: “set (future) inflation at 2%”. But it does not follow any instrument rule like the Taylor Rule. Instead it uses its discretion. It looks at everything it thinks might be relevant, and adjusts the nominal interest rate instrument accordingly to ensure that, in its own judgment, future inflation will converge to the 2% inflation target. “Simple rules” (in this context) means “instrument rules”. If the Bank of Canada kept the 2% inflation target, but used a Taylor Rule instead of discretion to try to hit that same 2% inflation target, it would be following a simple rule.

The simple instrument rule (“Taylor Rule”) appears to have worked well both in Canada and the US up to about 2006-07. But that conclusion is predicated on the fact that possible targets (IT, PLT or NGDP-LT) were observationally equivalent. The charts illustrate.

For Canada

For the US

What the crisis showed is that inflation or price level targets are not robust “target rules”. If an NGDP-LT target had been explicitly pursued, both the Fed and the Bank of Canada (and many other central banks) would have heard the “dog bark” loud and clear! (Note that the IT and PLT “dogs” “barked up the wrong tree”!)