

EPA/SHAWN THEW

The Republicans' latest plan to rein in the Federal Reserve is, to damn it with the faintest of faint praise, their smartest yet. But it's still nowhere near convincing.

It might be hard to believe, but Republicans weren't always so suspicious of the Fed's efforts to revive the economy. As Paul Krugman points out, you only have to go back to the last time a Republican was in the White House to see that they thought "aggressive monetary policy can reduce the depth of a recession." That's changed, though, during the Obama years. Now they think the Fed has gone too far, and compromised its independence in the process. Paul Ryan, for example, has said that the Fed's bond-buying "looks an awful lot like an attempt to bail out fiscal policy," and called for a commodity-based standard to replace our fiat one. That's just a hop and a skip, forget the jump, away from an outright gold standard—a barbarous idea whose time will never come again.

But here's the most perverse part. At a time of high unemployment, Republicans don't want the Fed to worry about it anymore. They only want the Fed to worry about keeping inflation low. That's because they think this kind of single mandate would have prevented the Fed from doing quantitative easing. But they're wrong. Former Bush adviser Greg Mankiw points out that, because inflation has been below target, the Fed probably could have justified its bond-buying even with only an inflation mandate. So Republicans need an even more restrictive plan if they want to handcuff the Fed.

And that plan can be summed up in three words: the Taylor rule.

Now, before we get to the details of the proposal, here's a little background. The Taylor rule itself is something all monetary economists have used since Stanford professor John Taylor proposed it in 1993. It's just a formula that says how the Fed should set interest rates based on inflation, and, to simplify a bit, unemployment. It might not always be the last word on policy, but it is the first. Indeed, back in 1995, then-Fed governor Janet Yellen explained that she used the Taylor rule to "provide a rough sense of whether or not the funds rate is at a reasonable level."

But Republicans want it to be the only word, or close enough to it. Specifically, they want to force the Fed to pick a mathematical rule for setting interest rates. The Government Accountability Office would then audit the Fed's decisions to make sure it was, in fact, following its own rule. And the Fed would have to explain to Congress 1) why it ever deviated from its rule, and 2) why its rule deviated from the Taylor rule, if it did.

This isn't just a ham-handed attempt to intimidate the Fed from doing what it thinks it should. It's also bad policy. Here's why.

1. The Taylor rule doesn't work when interest rates are zero. Take a look at the chart below. It compares what a simplified Taylor rule says interest rates should have been with what they actually were. Now, as you can see, the two track each other remarkably well—until 2008. That's not because the Fed suddenly stopped using the Taylor rule as a guide. It's because, in the aftermath of the crisis, the Taylor rule said rates should have been -7 percent, but, in the real world, the Fed couldn't cut them below zero.

(Note: Mankiw came up with this modified Taylor rule, and Krugman later re-estimated it).

What should the Fed do when the zero bound prevents it from setting rates where the Taylor rule says it should? Well, one answer, as you might have guessed, is quantitative easing. Another is forward guidance. But Taylor—the man, not the rule—has been a vocal critic of both. So it seems that committing to the Taylor rule the way he and Republicans, whom he advises, would have wanted would have meant much tighter money. Maybe not enough to turn our Great Recession into a full-on Great Depression, but at least enough to turn us into Europe.

2. Policymakers need flexibility. The world, as you might have noticed, has changed since 1993. And it's changing still. That's the problem with telling the Fed not only what to target, but how to target it, too: what worked before might not work as well in the future. Take the labor force. Unlike in 1993, it's shrinking now, and that, together with slower productivity growth, might—though this is hardly certain—push down the natural interest rate. The Taylor rule, though, assumes the natural interest rate is fixed, in inflation-adjusted terms, at 2 percent. In other words, it might have a tight-money bias now.

Or take unemployment. It's not clear how much, if at all, the headline rate is understating the slack left in the labor market. That's because there are still so many people either working part-time who want full-time jobs or are too discouraged to even look at all. So, once again, a strictly rule-based approach that only plugged in the official unemployment rate might have a tight-money bias.

3. Which version of the Taylor rule are we even talking about? Taylor first proposed his rule back in 1993, and, ever since, economists have been proposing their own tweaks. Some put more weight on inflation. Others put more on unemployment. But, in any case, there isn't any reason to enshrine the original Taylor rule into law over these other Taylor-type ones. Not there's any reason to enshrine any of them into law.

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Reform conservatives have been alone on the right in calling for the Fed to do more. They still are. Though this Taylor rule idea is better than the single mandate or commodity standard ones that Republicans have trotted out before, the point is still to stop the Fed from using unconventional policy.

In other words, Republicans are still more the party of Rick Santelli than Milton Friedman.