With just over a year remaining on Janet Yellen's current term as chair of the Federal Reserve, comments from three of her potential successors at this this weekend's annual American Economic Association meeting are noteworthy. Glenn Hubbard of Columbia University, along with Stanford University’s John Taylor and Kevin Warsh, are all seen by Fed watchers as potential future chairs should President-elect Donald Trump decide not to re-nominate Yellen. All three criticized the U.S. central bank for trying to do too much, and suggested interest rates would be higher if they were in charge.
There are two reasons Taylor should not lead the Fed:
1.) He is the leading proponent of having the Fed use mechanical rules to determine policy. Taylor authored the "Taylor Rule," an equation that he believes should completely govern the Fed's interest rate policy. The rule is very useful as a basis for policy discussion. Despite that benefit, Taylor's argument assumes his equation is infallible -- that it will always be correct in any circumstance. That assumption is incorrect; nothing, especially in economics, is that simple. There is always "another hand" that should offer policy guidance. And binding the Fed's hands would have prevented them from engaging in the extraordinary measures during and after the Great Recession.
2.) Taylor continually compared the Obama recovery to the Reagan recovery, an economic apples to oranges comparison. The Federal Reserve caused the recession preceding Reagan: They increased interest rates to wring inflation out of the economy -- a policy that worked brilliantly. Once rates started to move lower, the economy faced little to no structural headwind to naturally slow economic growth. Perhaps just as important, Reagan's tenure began just as the baby-boomers were beginning their peak earnings time in life. This started a long period when the labor force participation rate increased, adding additional stimulus to the economy.
Obama's recovery was preceded by an entirely different precursor: a debt-deflation recession and recovery. This is an entirely different economic scenario then that faced by Reagan and one that leads to a far slower recovery. In a post-debt deflation economy, consumers are burdened by debt values that, ins some cases, are higher than asset values, leading to slower spending as consumers allocate additional resources to paying down debt rather than other goods. The de-leveraging process can take years, acting as a slight to large drag on economic growth. And unlike Reagan, Obama faced a declining LFPR as the baby boomers started to retire, which also lowered GDP growth.
Taylor has yet to acknowledge either fact in his analysis. There are two possible reasons for his oversight. 1.) He is unaware of the difference between the recoveries. Given Taylor's stature, this is highly doubtful. But it this is the reason is is automatically disqualifying because it belies a profound ignorance of economic history. 2.) He is aware of the differences, but for political reasons refused to acknowledge them. This is the more likely reason. Taylor is a University of Chicago economist; he is inherently biased against government action and activist policy. However, if this is the reason, it is also disqualifying because it indicates he is more interested in political outcomes than positive economic outcomes.