Episode 24 - The Rules, Part II
We continue our conversation on monetary policy rules with an introduction to the most famous man behind the Rules Movement - John Taylor. Also I’ll introduce you to the law being tossed around the US Congress that would take monetary rules to a whole new height.
Welcome to The Bankster Podcast. I’m your host, Alexander Bagehot. Every episode we dive into what I call The Centralverse! The incredibly fascinating and ever more consequential world of central banking. This is Episode 24 - The Rules, Part II.
Many in today’s political sphere are looking for ways to decrease the size of the government, whether in size or influence. A dismantling of the Affordable Care Act would supposedly give more power to health care companies. A dismantling of the current, government sponsored public education system may be in the future, if the new education secretary has a say. One of President Trump’s executive orders requires that for every one new regulation the government creates, they have to get rid of two.
However, there is one law that is getting tossed around the US Congress that would actually increase the government’s control in an arena that has not had direct government interference for over half a century. One part of this law that is being debated, and it will surely get a new spotlight under the new administration, has to do with a monetary policy rule.
If you missed Episode 23, go back and check it out. In that one we gave an introduction to how monetary policy is currently made and a brief history of what a monetary policy rule is and some of the most famous rules. On today’s episode we dive deep into the man behind the most popular rule today.
Also, before we jump into the content I have to give a shout out to Vice Chairman of the Board of Governors - Stanley Fischer. He gave a presentation at the Warwick Economics Summit in Coventry, England last week. Now I'm not sure if Fischer has been listening to the podcast, or if we were just both on the same wavelength, but his presentation covered exactly what we discussed on Episode 23! So if you're interested in hearing more about the process that FOMC members go through when deciding monetary policy I highly recommend reading the speech. The Warwick Economic Summit is a completely university level student run conference, so although a stranger on the street might not be able to follow, if you've been listening to The Bankster Podcast, you will definitely be able to understand just about every single point he makes.
If you sign up for the show notes at www.thebanksterpodcast.com I'll send you a link to the presentation. Ok, anyways, always nice to see confirmation that we are on the right track. Now let's dive into The Rules, Part II.
Who is John Taylor?
The most famous man behind the monetary policy rules movement is John Taylor. Not only did his rule change the economic landscape forever, but he currently sits at or near the top of most lists for upcoming senior leadership positions at the Federal Reserve (including that of Chairman of the FOMC). But where did he come from? Well, let’s take a very brief tour through the impressive history of the economist John Taylor. (not to be confused with John Taylor, a British bass guitarist that I guess is more famous than the economist since he shows up the very top of the Google search John Taylor).
Nevertheless, Taylor (the economist)’s background deserves attention. Immediately upon graduation from Princeton University in 1968, Taylor moved across the country to pursue a PhD at Stanford. Finishing up five years later, Taylor accepted a position as a junior faculty member back on the east coast at Columbia University. As he moved back and forth across the landscape, Taylor quickly distinguished himself as a pioneer of the analytical computing applications to the field of economics.
After a few short years at Columbia, Taylor made his first move out of academia and into the realm of political policy. President Gerald Ford asked him to serve as a senior economist on the President’s Council of Economic Advisors from 1976 to 1977. He would return to that council again for most of the George HW Bush presidency. Taylor would also serve on a similar committee on the state level for California from 2005 to 2010.
His highest calling in government came in the George W Bush presidency. For four years, from 2001 to 2005, Taylor served as the Undersecretary of the Treasury for International Affairs. During this time Taylor played a major role in the economic policy and governmental response to 9/11 and the recession of 2001.
In all of the gap years, and sometimes simultaneously, Taylor has taught at Princeton, Columbia, and Stanford (his current home). He is now the Director of the Stanford Introductory Economics Center.
So there’s a little bit of basic background for you on the works of John Taylor. Just to give you an idea of how large of an impact Taylor has had on the field of monetary economics, I want to end this section with a quote from Ben Bernanke. The setting of the quote is also worth mentioning. In 2012 the Federal Reserve Bank of Dallas hosted a conference with the title, “The Conference on John Taylor's Contributions to Monetary Theory and Policy”.
Bernane, then the Chairman of the Federal Reserve System, said the following during his opening remarks, “It is a privilege for me to open this conference dedicated to our colleague and friend, John Taylor. John's influence on monetary theory and policy has been profound indeed. That influence has been manifest in undergraduate lecture halls and graduate seminar rooms, in the best research journals, and in the highest ranks of government. His ability to crystallize important analytical insights and apply them to policy issues is unsurpassed.”
So that’s a brief intro to John Taylor. Most of the information I’ve cited came from his website and the speech by Ben Bernanke. If you want more information about Taylor’s economic contributions, Bernanke’s article is a great 5 minute read that summarizes Taylor’s three biggest contributions to the Centralverse.
Now we turn our attention to the FORM Act.
On July 23, 2015 a bill was introduced in the House called the Fed Oversight and Reform Act of 2015 (FORM Act, for short). If you can’t remember what the political atmosphere in the country was a little over a year and a half ago let me remind you. Donald Trump had already been in the race for the Republican nomination for President for six weeks. South Carolina had recently removed the Confederate Flag from their state capitol building. Also, the US had barely opened their embassy in Havana as Cuba opened its embassy in DC for the first time in 54 years.
So that’s the setting. While all of those political events were happening around the country the US House was beginning the debate on the so called, FORM Act. A few months later, on November 19, 2015, and after a number of debates in the halls of Congress, the House passed the FORM Act by a vote, with little exception, divided on party lines.
Within a few weeks the Act made it to the desk of the Senate’s Committee on Banking, Housing, and Urban Affairs. But that’s where the Act has been ever since. And for those a little rusty on their US Civics, before an Act of congress can become a law, it must pass the house and the senate and then be signed by the President. So the FORM Act has been stuck at stage two of the process for a little over a year. With the new direction that the White House appears to be taking policy discussions in Washington these days, it’s anybody’s guess where the FORM Act currently stands on the list of priorities for the Republican controlled government.
At this stage in the conversation you may be asking yourself, “Ok, so that’s the current political status of the change the Fed act, but what does the Act actually say? What impact would it have on the Federal Reserve?” And those would be perfectly reasonable questions. They are the very ones that led me to begin this “Rules Series” on the podcast in the first place.
I went through the Act that passed the house and wrote down nine significant changes and loosely ranked them from highest impact to lowest impact. On today’s podcast I’ll describe and explain the top five. Then, if you sign up to receive the show notes I’ll send you my summary of all of the nine potential changes that the FORM Act would impose on the Federal Reserve.
Within 48 hours of the FOMC meeting the Fed Chair must submit the Directive Policy Rule. Yep, that is the monetary policy rule. And by making the Chair report what the Rule is to congress, they are forcing the Fed to have a specific rule. It’s important to note that the Chair already does tell congress what and why the Federal Reserve has done what they’ve done, but now (if the FORM Act passes) they will be required to include a specific mathematical rule that explains the Fed’s actions.
If the Rule has changed since the last time, the Fed Chair has to explain why. This discourages the Fed from using a variety of rules and going back and forth between them.
GAO can audit conduct of monetary policy whenever congress asks. An audit of monetary policy would include this government agency, the GAO, walking into the Fed buildings across the country and looking into how the Presidents and Governors are doing their research.
A deeper restriction on the FOMC’s ability to make emergency loans. The word “deeper” is used because since the Financial Crisis the ability to make emergency loans has already been restricted and limited. The Dodd Frank act required that 5 of the Governors sign off on an emergency loan and that the loan be available to at least 5 institutions. This would prevent the Fed from making one-off loans like the one to AIG. The FORM Act would further limit this lending power by requiring that 9 of the 12 Reserve Bank Presidents from around the country also sign off. (interesting article on legal status of the Fed making emergency loans by a University of Chicago professor).
Voting members of the FOMC at each meeting would increase from five presidents to six. As it currently stands, and you can see a colorful chart on my website if you learn better with visuals, the New York Fed always gets a vote. That leaves 11 remaining Presidents. Chicago and Cleveland rotate every other year. The remaining nine Presidents rotate every third year. The FORM Act would change this, all of the Reserve Bank Presidents would become equal. Each President would vote every other year.
So those are five of the nine most significant changes that the FORM Act would have upon the structure of the current Federal Reserve. It will be fascinating to see what the new president and congress decide to do. I hope you’ll return to this episode when Congress decides to take up changes to the Fed structure. Who knows when that will be? But I’ll be there when it does!
As always, feel free to drop me a line with comments and questions about the Centralverse or the Bankster Podcast via email (email@example.com) or Twitter or Facebook. Have you looked at the FORM Act or heard about other ways the Fed might be structurally changed. If you have, send me a note and let me know what you think.
If you go to my website, www.thebanksterpodcast.com you can sign up to receive the show notes to today’s podcast and every future podcast directly in your inbox. This week I’ll include the other changes to the Fed that the FORM Act would require.
Thanks to all of you who have submitted reviews on your podcast apps. For those of you who haven’t written a review, it really does help and only takes a few minutes to do. I hope you’ll take a moment to do so.
Today’s episode was written, edited, and produced by me, Alexander Bagehot. I dedicate this episode to John Taylor - For starting one of the most important debates in the Centralverse for our generation. To the rest of you, thanks for listening! I’m Alexander Bagehot, and I’ll see you next time on The Bankster Podcast!
6) GOA determines if DPR has materially changed from the rule most recently submitted DPR
7) Fed must publish stress test info to institutions and GOA/congress
8) Increase from 2 to 4 of Chair testimonies before congress
9) Class B and C directors should represent underserved communities
10) Centennial Monetary Commission to examine how U.S. monetary policy since the creation of the Board in 1913 has affected the performance of the U.S. economy in terms of output, employment, prices, and financial stability over time.