Notes From Underground: Questioning the Taylor rule

The biggest story from the weekend is Federal Reserve Chairman Ben Bernanke’s speech at the American Economics Association in Atlanta. Bernanke calls for more regulation for the banking system, rather than using the hammer of  interest rates to prevent the onset of bubbles, especially in the real estate market. Calling for greater “systemic regulation” is a way for the FED to claim that it was not Fed policy that led to the current crisis, but rather the lax oversight of regulators. The FED chairman utilizes the Taylor rule to disallow FED responsibility for the housing bubble.

Many FED critics point to the sustained low rates in the early part of the decade that made the housing bubble inflate to such detrimental levels that affected the entire financial system. Bernanke defends the prolonged low rates as based on the Taylor rule. It is interesting that the Fed chairman uses this veil of inflation policy in the low rates policy of 2002-2004 but then goes on to take credit for the FED overriding the strictness of the Taylor rule during the present credit crisis. In a article on the FED chairman’s speech, Bernanke goes out of his way to say that the Taylor rule would have recommended the FED raise rates to a range of 7-8% through the first three quarters of 2008. Mr. Bernanke says that this would have been “a policy decision that probably would not have garnered much support among monetary specialists.” He goes on to explain that the FED focused on anticipated rates of inflation and not actual rates. So here we have spelled out that the FED has an asymmetrical bias that lends itself to being a serial bubble blower. The FED utilizes the models we have when they fit our preconceived view, but override them when we need a different outcome.

We agree that the FED would have been insane to raise rates in 2008 regardless of the Taylor rule, but this speech gives us pause to trust the judgment of the U.S. central bank and this is the problem of policy going forward. The call for greater systemic regulation is a smoke screen to hide the errors that the FED has repeatedly made. The rules for banks are already in place and the FED did a lousy job ensuring they were followed. Also, the Greenspan FED was a cheerleader for the use of adjustable rate mortgages that Bernanke now says needs more regulation.

The FED should be promoting a return to Glass-Steagall and the end of proprietary bank trading rooms putting the entire global system at risk. The split between commercial and investment banks allows the “brains” at the investment banks to act as fiduciaries for the entire system in a real-time basis. By removing the investment banks’ role, the entire system was shaken by the huge rewards that could be gained trading against their clients.

There was further news out of Russia in regards to energy. The Russians cut off shipments of crude oil to Belarus because of a tariff discrepancy  on Russian-exported oil. Minsk and Moscow had a previous arrangement that subsidized Belarus’s export of refined products to Europe. This subsidization allowed Belarus to sell crude products cheaper than Russian concerns because of the export tax they had to pay. Russia wants to end this and wants Belarus to pay the same export tax. The crude cutoff is not as severe as natural gas because crude is more readily available. The pattern that is developing is that Russia continues to use energy to flex its muscles in Europe. This will be an ongoing story as the Russians’ desire to find a way back onto the world stage, especially in the realm of global energy needs.

We also want our readers to be aware of an article in Monday’s Financial Times about why the developed nations cannot spurn emerging market investment. This is a theme that we will pay close attention to this year as the role of sovereign wealth funds (SWF) will play a dynamic role in the global financial world. (China’s GEELY buying Sweden’s Volvo from Ford is a precursor.)

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One Response to “Notes From Underground: Questioning the Taylor rule”

  1. Eric Says:

    Well put

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