Another Taylor Rule

Or at least it seems to be a new rule — namely, pick whatever price index makes the point you want, even if it’s not at all the price index you would normally use.

Via EconoSpeak, John Taylor says that the U.S. economy was too experiencing a substantial acceleration of inflation during the years when he says monetary policy was too loose:

Inflation was not steady or falling during the easy money period from 2003-2005. It was rising. During the years from 2003 to 2005, when Fed’s interest rate was too low, the inflation rate for the GDP price index doubled from 1.7% to 3.4% per year. On top of that there was an extraordinary inflation and boom in the housing market as demand for homes skyrocketed and home price inflation took off, exacerbated by the low interest rate and regulatory policy.

Um, the inflation rate for the “GDP price index”? That’s the GDP deflator, which the Fed very carefully does not use as a policy indicator. Why? Because it contains things like grain and oil prices, which fluctuate a  lot, so that it’s an unstable measure that is highly unreliable as an indicator of underlying inflation. The Fed prefers the consumption deflator excluding food and energy. Here’s how the two compare since 2000:

Do you really think that the blue line, which has fluctuated wildly, should have been used to guide monetary policy? Was Taylor calling for gigantic monetary expansion in 2009, when the GDP deflator almost went negative? And using the Fed’s preferred measure, inflation was indeed quiescent during the “Bush boom.”

Oh, and if you’re going to use home prices — not rents — as a measure of inflation, you should know that it looks like this:

Again, wildly erratic (even more so) — and, by the way, negative when Taylor signed the debasement and inflation letter.

Actually, there’s a broader point. Taylor’s argument is that monetary policy was too loose during the boom; it’s also that monetary policy has been too loose during the slump. So it has basically always been too loose, for a decade or more. Yet inflation is lower now than it was in 2000. How is that possible?

The New York Times