More than a decade of unpredictable monetary policy from the Federal Reserve is ailing the U.S. economy, and the central bank should start to correct the problem next week by raising interest rates, the prominent Stanford economist John Taylor said Thursday in Minneapolis.
"I think that's part of normalization, that's part of getting back to a policy that we understand would work, so I would be for it," Taylor said.
One of the world's leading economists and long a proponent of rules-based Fed policy, Taylor said the economy responds well when the nation's monetary policy is based on predetermined responses to changes in inflation and output. U.S. monetary policy was largely predictable from 1980 to 2000, but has since lost its way, he argued.
The shift began well before the recession. Between the late 1990s and the early 2000s the economy didn't change dramatically but interest rates dropped to around 1 percent by 2003. "That is a big change," he said. "I think it's one of the reasons we had a search for yield and risk-taking, and we ultimately had excesses."
Since then, the federal funds rate has been remarkably low aside from the two years before the financial crisis, and the Fed's balance sheet quadrupled to over $4 trillion as the central bank purchased bonds to try to stimulate the economy in a program known as "quantitative easing."
"There's debate about its impacts, but you cannot argue that it's rule-based or predictable," he said.
Taylor spoke to the Economic Club of Minnesota ahead of a meeting of the Fed's rate-setting Open Market Committee next week, when it could end the nation's prolonged period of zero interest rates.
The audience included Federal Reserve Bank of Minneapolis President Narayana Kocherlakota, now a nonvoting member of the committee. During the speech, Taylor looked toward Kocherlakota, a proponent of the Fed holding interest rates down through the end of the year.
Janet Yellen, the Fed's chairwoman, signaled earlier this year that the Fed would raise rates before the end of the year, and many economists and investment analysts have believed the process would begin with the Sept. 16-17 meeting. But weakness in the Chinese economy and stock market turmoil in recent weeks has cast doubt that the Fed will act.
Taylor said central banks around the world tend to follow each other, and other central banks — notably Japan's — have followed America's lead in setting an extraordinary monetary policy course.
Taylor also pushed for the Federal Reserve to report its monetary policy strategy to Congress, which is a provision in bills before both houses.
"We should get back to a more predictable, steadier, less discretionary, more consistent kind of policy," he said.