Monetary Rules for a Post-Crisis World

behavioral economics, Market Monetarism, monetary rules, NGDP targeting, Taylor Rule
The second panel at "Monetary Rules for a Post Crisis World," September 7, 2016. Photo credit: Nick Donner

behavioral economics, Market Monetarism, monetary rules, NGDP targeting, Taylor RuleEarlier this month a crowd of over a hundred and fifty gathered at George Mason University’s Arlington Campus for an academic conference co-hosted by the Mercatus Center and the CMFA. The conference, “Monetary Rules for a Post-Crisis World,” featured leading monetary economists, Washington’s top financial journalists, and John Taylor, famed author of the eponymous rule, who delivered its keynote address.

Panel I: The Evolving Case for Monetary Rules

The first speaker of the opening session, which was moderated by The Washington Post’s Ylan Q. Mui, was the University of Western Ontario’s David Laidler.  Drawing on both monetary history and the history of monetary thought, Laidler argues that it was unreasonable to suppose that any monetary rule that proved successful for a time would continue to work well indefinitely.  Consequently, Laidler preferred a looser “monetary order” to any legislated, let alone quasi-constitutional, monetary rule. By such a monetary order Laidler meant, among other things, (1) a set of general goals assigned to the monetary authorities; (2) institutional arrangement conducive to achieving those goals; (3) specific procedures for revising either the goals themselves or the arrangements for achieving them; and (4) means for holding monetary authorities accountable for their failure to achieve their goals.

David Glasner, an economist at the Federal Trade Commission, complemented Laidler’s historical arguments. He traced the origins of the rules debate to mid-19th century Britain. Frequent financial crises after the Napoleonic Wars led to clamor for a comprehensive law to either fix the price of gold or limit the quantity of bank notes in circulation. In Glasner’s view, the history of monetary rules shows that price rules aren’t consistent with economic stability, while quantity rules are easily undermined.

Our own Mark Calabria took a different view, drawing upon insights from behavioral economics that support rules. He pointed to cognitive biases that cause policymakers to make poor choices: availability bias, representativeness bias, loss aversion bias, and overconfidence bias. Experience and expertise can sometimes help people overcome bias. But, studies suggest that experts can be inferior to simple algorithms in irregular, unpredictable environments. Calabria concluded that rules based policy can outperform discretion because monetary policy is irregular and unpredictable.

Panel II: Monetary Rules and Monetary Stability

The second panel featured the Richmond Fed’s Robert Hetzel, University of Houston’s David Papell, and Mercatus’ Scott Sumner, moderated by Ryan Avent of The Economist.

Hetzel discussed problems with the Fed’s current economic projections. These projections don’t provide enough information for analysts to tell when the Fed deviates from its regular policy. Hetzel proposed the FOMC expand them to include annual inflation and the price level, potential real GDP and real GDP, and a future path of the fed funds rate that supports those projections. According to Hetzel, these new projections would provide information academics need to better explore connections between policy and the real economy.

Papell considered which rule the Fed should use if the FORM Act becomes law. The Act, which recently passed the House, more or less requires the Fed to follow a rule of its own choosing. Papell used three criteria to evaluate possible rules: consistency with long-term economic performance, consistency with Fed policy since the Recession, and consistency with projected future Fed policy. He tested several rules, including the classic Taylor rule, the 1999 version of the Taylor rule that doubles the coefficients on the output gap, and a recent proposal of Janet Yellen’s that incorporates time-varying interest rates. According to the tests, Yellen’s most satisfied his criteria.

Scott Sumner closed the panel by making a case for Market Monetarism. Sumner touted Market Monetarist ideas as explaining the weak recovery best and as offering the largest benefits to future policymaking. According to Sumner, under NGDP futures targeting, a Market Monetarist proposal, monetary policy would be both rules- and market-based. Moreover, Sumner claimed that the worst of the Recession would have been avoided had NGDP futures targeting been used before 2008.

Luncheon Address: John B. Taylor

Following lunch, Taylor addressed the crowd, reviewing the recent history of monetary policy. During the great moderation, monetary policy resembled what the Taylor rule prescribes. However, in the 2000’s policy deviated, leading to the bubble and crisis. Monetary policy if anything has “gotten weirder” since 2008. The past decade caused Taylor to think critically about the legal architecture governing monetary policy; he remarked that central bank “independence is good but it doesn’t seem to have delivered.” Taylor has advocated a “remarkably simple” legislative remedy since publishing a 2011 Cato Journal article on the subject: a law requiring the Fed to publicize a rule, of their own choosing, used to set policy. Taylor’s view served as the basis for the FORM Act.

Panel III: Monetary Rules and Emergency Lending

The third panel, moderated by FT Alphaville’s Cardiff Garcia, investigated how a monetary rule might affect a central bank’s lender of last resort function.

Perry Mehrling of Barnard College suggested updating Bagehot’s Dictum to account for shadow banking by requiring that central banks only sell emergency liquidity when an entire market, rather than a single institution, requires it, and that central banks only make emergency asset purchases at outside bid-ask spreads. Mehrling also argued that central banks should not be in the financial stability business. He advocated for a banking regulatory regime that does not restrict a “robust private dealer system of first resort.”

Kevin Sheedy of the London School of Economics then argued that post-crisis unconventional monetary policy is inherently not rule-like. An effective rule must target a consistently optimal policy and be subject to minimal political pressure. Unconventional policy fails on both counts. Long-run efficient allocation of credit is sacrificed for a short-term economic boost, while discretionary, outsized credit allocation begs political meddling.

Walker Todd, a Cato adjunct fellow and occasional Alt-M contributor, closed out the panel with his presentation titled, “Emergency Lending at the Federal Reserve: The Gateway Drug for Quantitative Easing and Other Monetary Disorders.” Todd forcefully argued that any emergency lending the Fed engages in must be rule bound.  Rules should limit the direction of emergency credit towards solvent traditional banks with direct involvement in the payments system.

Panel IV: Monetary Rules in Light of the Crisis

The day’s final panel was moderated by The Wall Street Journal’s Greg Ip. In addition to ably facilitating the presentations, Ip also engaged in a lively discussion with the panelists about how monetary policy relates to economic growth.

The Mercatus Center’s David Beckworth discussed what he called “The Fed’s Dirty Little Secret;” that “by design QE was not going to spark a robust recovery.” People had no incentive to change their spending behavior because QE injections of base money were designed as “temporary.” Beckworth offered a NGDP level targeting regime as a sound path forward from the failures of QE.

Miles Kimball, who recently became Eaton Chair of Economics at the University of Colorado Boulder, discussed new research ideas relevant to interest rate rules. Perhaps the most au currant of these ideas was negative interest rates, something Kimball has been a leading evangelist for. In Kimball’s view, negative rates must be possible for interest rate targeting policies to work. More broadly, flexible, accurate interest rate targeting offers a host of economic benefits, according to Kimball. These include closing output gaps and stabilizing inflation within a year.

Wrapping up the conference was Peter Ireland of Boston College, who presented a working paper co-authored with the University of Mississippi’s Mike Belongia, “Circumventing the Zero Lower Bound with Monetary Policy Rules Based on Money.” Most macroeconomic models suggest monetary policy loses its effectiveness as interest rates approach zero. Ireland argues that monetary policy based on the quantity of money could still be effective at the zero lower bound. Ireland suggested an NGDP targeting regime that focuses on changes in money rather than interest rates would work even at the ZLB.

Full Video!

If you want to catch the full presentations, moderated discussions, and audience Q&A, a play list of the conference video coverage can be found here, and more information about the conference program is available here .


  1. LOL Last question? Larry White! Boom! And the two responses were classic. One, gee whiz we fear that free banking will lead to monopoly. LOL, hello, we have a monopoly now! The second response? Oh, we've advanced past the need for any constraints (a gold standard) outside government/monetary authority. Look at the results everybody. Interest rates are zero to negative out to 30 years in true real terms for the entire developed world. And, the US $ has declined by more than 99% in the last 100 years, as the gold standard has been obliterated. Is there any better example of defending the undefendable?

    Rules vs discretion, like Republican vs Democrat, or graduated tax rates vs a flat tax, is a complete kinard designed to maintain State control of the monetary and banking systems. As long as we are having the rules vs discretion debate, nothing positive can happen. Private money and free banking, with the free adoption of other standards including gold, is the obvious solution.

  2. The money supply (& DFI credit or their loans and investments), can never be managed by any attempt to control the cost of credit (i.e., thru pegging the interest rate returns on government securities; or thru
    "spreads", "floors", "ceilings", "corridors", "brackets", IOeR, etc.).

    I.e., the Fed's monetary transmission mechanism, interest rates, is non sequitur. Interest is the price of loan-funds, not the price of money. Keynes's liquidity preference curve (demand for money), is a false doctrine. That's what the Treasury-Federal Reserve Accord of 1951 was all about.

    And reserve targeting worked well until William McChesney Martin Jr., abandoned the FOMC’s net free, or net borrowed, reserve targeting approach in favor of the Federal Funds “bracket racket” beginning in c. 1965 (coinciding with the rise in chronic monetary inflation & in anticipated inflation).

  3. Monetary policy objectives should be formulated in terms of desired rates-of-change, roc's, in monetary flows, M*Vt (our means-of-payment money times its velocity of circulation), relative to roc's in R-gDp.

    Roc's in N-gDp (though "raw materials, intermediate goods and labor costs, which comprise the bulk of business spending are not treated in N-gDp"), can serve as a proxy figure for roc's in all transactions, P*T, in Yale Professor Irving Fisher's truistic "equation of exchange" (where the
    proper index # provides clues to the overall economies' "price-level"). Roc's in R-gDp have to be used, of course, as a policy standard.

    This is inviolate and sacrosanct (tested with time for over 100 years – still unbeknownst to the 300 Ph.Ds. employed on the Fed's technical/research staff). And I just recently disclosed my proprietary math after keeping it a secret for 35 years.

    Yale Professor Irving Fisher – 1920: "The Purchasing Power of Money"

    "In my opinion, the branch of economics which treats of these five regulators of purchasing power ought to be recognized and ultimately will be recognized as an EXACT SCIENCE, capable of precise formulation, demonstration, and statistical verification."

  4. We knew this already. In 1931 a commission was established on Member Bank Reserve Requirements. The commission completed their recommendations after a 7 year inquiry on Feb. 5, 1938. The study was entitled "Member Bank Reserve Requirements — Analysis of Committee Proposal"

    It's 2nd proposal: "Requirements against debits to deposits"

    After a 45 year hiatus, this research paper was "declassified" on March 23, 1983. By the time this paper was "declassified", RRs had become a "tax" [sic].

  5. "Besides funding loans with retail deposits banks can and do fund them by borrowing on wholesale markets"

    Absolutely dead wrong. This applies to an individual bank's operations. It does not apply systemically. Never are the, CBs intermediaries in the savings-investment process. Bank-held savings are lost to both investment and consumption, indeed to any type of payment or expenditure. From the standpoint of the system, bank-held savings are un-used and un-spent.

    CBs, as a system, simultaneously pay for all their earning assets with new deposits (not old deposits). The CB's earning assets, which are erroneously regarded as being derived from attracting savings, actually were already in existence before the said: time/savings deposits even
    came into being! Bank-held savings have a zero velocity. Deposits are the result of lending, not the other way around.

    That is to say CB time/savings deposits, unlike savings-investment accounts in the “thrifts” (non-banks), bear a direct, one-to-one relationship, to transactions accounts. As time deposits, TDs, grow, transaction deposits, TRs, shrink, pari passu, and vice versa. The fact that currency may supply an intermediary step (i.e., TRs to currency to TDs, and vice versa) does not invalidate the above statement.

    The source of all time/savings deposits to the system, are other bank deposits, directly or indirectly via the currency route, or thru the CB's undivided profits accounts (i.e., all time/savings deposits are the indirect consequence of prior bank credit creation) – and the source of new demand deposits can largely be accounted for by the expansion of bank credit.

    From the standpoint of the system, the monetary savings practices of the public are reflected in the velocity of their deposits, and not in their volume. Whether the public saves, dis-saves, chooses
    to hold their savings in the commercial banks or transfer them to a non-bank conduit, will not, per se, alter the forms of these assets and liabilities. I.e., the CBs could continue to lend even if the non-bank public ceased to save altogether.

    All monetary savings originate within the commercial banking system. And savers never transfer their savings outside the system (unless they hoard currency). The NBs are not in competition with the CBs (as virtually all Congressional legislation assumes). The NBs are the CB’s customers. The transfer of the ownership of savings deposits to the NBs does not reduce or extinguish them or cause them to be withdrawn from the CBs. It merely transfers title / ownership of existing deposits, all of which are held within the confines of the CB system. Bank-held savings are a universally un-recognized leakage in Keynesian National Income Accounting procedures.

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