No ‘Taylor rule’ without Meltzer’s support

The “Taylor rule” and its momentous impact on economic thinking might never have come to be if it was not for the intervention of Allan Meltzer, who died recently aged 89.

Stanford economics professor John Taylor, after whom the rule is now named, presented a paper setting out a simple rule that could capture the most important elements of monetary policy decisions at a conference in 1992. It was Meltzer who encouraged him to pursue the formulation of the rule.

Taylor writes in an article for Central Banking that at the time, people were arguing about the rules and warning they would have to be very complex to adequately represent monetary policy. Meltzer “thought otherwise” and pushed Taylor to work more on the problem.

“If he had not invited me to give that presentation and write that paper at that time, I would likely have done other things,” Taylor says.

Ultimately the rule showed it was possible to produce an accurate approximation of the monetary policy stance using just two variables and the coefficients applied to them – the deviation of inflation from target, and that of output from its long-run trend.

Taylor later developed the work further, arguing such a rule could be used to set policy in a predictable fashion as well as to analyse appropriate policy settings. He won Central Banking’s 2016 award for economics for his work in applying the rule to monetary stability on a global scale.

Taylor writes that the support Meltzer showed for the policy rule was typical of the economist’s “constructive influence” on other economists. “He opened a window for me to see serious policy-orientated research and to meet economists and policymakers who were committed to applying this research,” he says.

Meltzer was a supporter of rule-like monetary policy-making throughout his career, arguing such certainty was an important prerequisite for effective, credible policies. Through this work, he shaped much of the thinking on modern-day central bank governance and independence.

“More than any other monetary economist, he looked for and examined the reasons for the mistakes, and he focused on two basic reasons: political interference with policy; and mistaken beliefs about policy,” Taylor writes.

Meltzer was not always popular with central bankers however – he, Taylor and a group of other US economists signed a statement in 2015 calling for the Federal Reserve to be bound by a simple policy rule. The central bank’s officials have resisted such pressure so far, but debate continues.

Though he would not hold back criticism where he felt it was deserved, Taylor says Meltzer avoided the personal attacks that some other economists have turned to. “Regarding US Federal Reserve Board decisions, for example, he wrote in his History [of the Federal Reserve] that, ‘although I find many reasons to criticise decisions, I praise the standards and integrity of the principals’.”