John Taylor is a respected professor of economics at Stanford University. This week he has becoming a leading figure in the political debate over the stimulus package. When I was at Stanford, Taylor’s economic views were prominent. He was on the White House Council of Economic Advisors during the recession of the early 1990s and his rule for monetary policy was widely adopted by central banks around the world. He did not seem like the extremist that the government painted him in Parliament this week — that’s because he isn’t one.
There is a core debate in macroeconomics regarding whether rules are better than discretion. A rule is a set of policies that are adopted and then left to their own devices. Designed right, when economic activity looks like tumbling, they automatically inject liquidity into the system and restore budgets from surplus to deficit. They do the reverse when the economy is growing. It is the macroeconomic equivalent of an autopilot.
Discretion is where you drive yourself. You gather information about the economy and you tailor a response. This is good if each cycle has unique circumstances but it is bad in the sense that the government reaction might be unpredictable and governed by non-economic factors.
To many economists, myself included, rules done right have real appeal. For starters, you don’t have to worry about the lag between gathering information (“waiting for the data to come in”) and your ability to fashion upon a response. It happens automatically. In addition, private agents know what the government is doing or not doing and can plan accordingly. Commitment of this kind is a key tool in the macroeconomic policy game just as it is in any policy setting.
The problem with rules is that they might be out of alignment or simply fail to work. This is the issue right now where monetary policy rules are not working and we appear to be in a liquidity trap.
As an analogy, consider the difference between cooling your house based on a thermostat, versus managing the temperature yourself. Thermostats adjust and save you from the work of monitoring the temperature and reacting to it. The problem is that they sometimes over-shoot and in extreme weather you might want to hit the override switch.
John Taylor has been the leading proponent and researcher on the desirability of rules. This has its origins with Milton Friedman. It is a view borne of the Great Depression and government mismanagement and it is entirely consistent with both Keynesian and neoclassical streams of economic thought. Put simply, it is mainstream economics.
Taylor, like most of us, justifies his beliefs on his reading of the evidence. And let’s be clear about this — the evidence on the helpfulness of discretionary fiscal policy is not at all clear. We don’t know whether handouts really stimulate and when they do. And not surprisingly, one might be reluctant to hand over the wheels of discretion in that information vacuum. This is not an extremist view. This is entirely reasonable given our evidence on discretionary fiscal policy. And up until recently, it was the view held by many macroeconomists including those in the RBA and Treasury.
At the recent AEA meetings, John Taylor reviewed the evidence. Based on the two temporary tax rebates in the US in 2001 and 2008 he argued that there is no evidence these stimulated consumption. He also argued that monetary policy could still work to stimulate the economy. While the recent experience might change those views, he is correct in stating that the evidence is not at all clear. It is certainly not a view that warrants an attack by the Government on John Taylor’s economic credentials.
But let’s turn now to the Coalition’s use of John Taylor. Malcolm Turnbull states correctly that Taylor would like to see permanent tax cuts used as a stimulus in the US. Okay, then at the very least, he should propose them! The Coalition has only proposed bringing legislated permanent tax cuts forward. That does not change permanent income and provides no additional stimulus beyond what would come from discretionary hand-outs. It is discretionary and not rules-based and I cannot imagine that John Taylor would see it as vindication of his position. So if the Coalition is serious then it should propose permanent policy changes that allow for better automatic stabilisation. Don’t dress up policies that are, aside from their targeting, identical to the the Government’s.
Put simply, we are already following Taylor’s policies. The government has been doing it for the last year ever since tax cuts were legislated. Moreover, we still have a structural surplus even with the government’s proposed stimulus. As far as I am concerned the Government’s patron saint of economics is John Taylor more than anyone else.
My own view is that the current Government stimulus package is an insurance policy. It is not clear it will work but given lags and the size of the economic event we are facing, it is a policy I think we should adopt. If worse comes to worse, low to middle income households will have more savings, our schools will have shiny libraries and our roofs will be insulated.
Joshua Gans is an economics professor at Melbourne Business School. He writes on these issues at economics.com.au.