John Taylor on the Federal Reserve

Stanford economics professor John Taylor has a

new paper

in which he takes aim at recent economic policy, and fires with both barrels, concluding that “government actions and interventions
caused, prolonged, and worsened the financial crisis.”

Taylor begins
with an argument he articulated at the 2007 Jackson Hole conference that excessively loose U.S. monetary policy in 2002-2005 was a factor contributing both to the housing boom and subsequent housing bust. The solid line in the figure below shows the actual path that the fed funds rate followed over this period, with the dashed line reflecting what Taylor believes would have been closer to the optimal response.



Source: Taylor (2007).



Taylor’s counterfactual simulations suggest that these excessively low interest rates set by the Fed were a key factor causing the unsustainable housing boom, the consequences of whose collapse we are still trying to recover from.



Source: Taylor (2007).
taylor_counterfact2.gif



Taylor also challenges the claim that the low interest rates of 2002-2004 could be attributed to a global savings glut, noting that total world savings was in fact an unusually low fraction of GDP.



Global Saving and Investment as a Share of World GDP. Source: Taylor
(2008)
.
taylor_savings.gif



Taylor also reviews the evidence that interest rate differentials such as the LIBOR-OIS spread reflected default risk rather than liquidity shortages. In Taylor’s view they did, in which case the new Fed measures such as the Term Auction Facility could have done little to affect the targeted interest rate spreads.



Source: Taylor
(2008)
.
taylor_taf.gif



Taylor further offers support for the proposition that by cutting interest rates too quickly at the start of 2008, the Fed aggravated the commodity price boom which in turn was one factor contributing to the recession of 2008.



Source: Taylor
(2008)
.
taylor_oil.gif



Although Taylor makes a number of valid points, I feel he overstates the role of the Fed in directly causing all the problems. I would instead point to inadequate regulation of key financial institutions as the single most important factor that brought us where we are today. I read Taylor’s evidence as providing further support for the view that when we
ask too much of monetary policy,
it can do more harm than good. The Fed tried too hard to fight the jobless recovery of 2002-2004 with monetary stimulus, and that ended up making the severity of the subsequent downturn in housing that much worse. The Fed tried too hard to prevent a downturn by bringing interest rates down so quickly at the beginning of 2008, and that ended up aggravating the oil price shock and ultimately making the hit to the auto sector in the first half of 2008 that much worse. And the Fed tried too hard in a futile effort to narrow default-risk premia, leaving itself with awkward balance sheet problems that will be tricky to resolve without aggravating our problems even further.

“You can’t blame a guy for trying,” the saying goes. But one reading of Taylor’s evidence is that we might be quite justified in doing just that.



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35 thoughts on “John Taylor on the Federal Reserve

  1. GK

    But oil pirces subsequently fell, even as the FF rate remains low. Why did he cut off the graph only while oil prices were still high?

  2. GK

    The ‘optimal response’ suggests raising interest rates sharply right after 9/11. Clearly, that would not have happened. I don’t think the Fed had much choice in 2002 from doing what they did.
    They could have managed 2003 and 2004 better, but low rates in 2002 was a must.
    Also, the optimal response and real FF rate converge in 2006. So there were still 2 years of high rates before everything crashed.

  3. knzn

    Taylor further offers support for the proposition that by cutting interest rates too quickly at the start of 2008, the Fed aggravated the commodity price boom which in turn was one factor contributing to the recession of 2008.
    This seems like a pretty bizarre argument to me. The recession had already begun by the beginning of 2008, and it could reasonably have been anticipated during the last months of 2007. So he’s saying that the Fed should have stood by and let the recession happen even though the core inflation rate was at an acceptable level and there was no evidence that it was rising. I grant you that, as Monday morning quarterbacks, we may be able to say that the Fed’s action had bad consequences (though I’m not entirely convinced even of that), but how could the Fed, acting on the basis of some sort of anticipatory “Taylor rule”, possibly have acted differently?
    I also grant that, after the fact, or perhaps even before the fact, Professor Taylor can come up with a version of his rule that would not have had the Fed cutting rates so fast. But then he is first of all requiring a particular interpretation of his rule, and we need him as an oracle to give us the true interpretation.
    More importantly, he is basically saying that the Fed should be backward-looking instead of forward-looking. That’s just silly. I know that the classic version of Taylor’s rule is indeed backward-looking, but I repeat, that’s just silly. Monetary policy affects the economy with a lag; to the extent that the Fed can be confident in its forecasts, it should take that lag into account. The Fed’s forecasts were, if anything, too optimistic (which is to say they were conservative from the point of view of motivation to cut interest rates), and the Fed acted according to those forecasts. Damn, if you’re going to be completely backward looking, I don’t see much point in putting in the employment gap (or output gap), because you’re always going to be too late to have much more than a 50/50 chance of affecting it in the right direction.
    I can see using a degenerate version of the Taylor rule, in which it depends only on past inflation. I don’t think that’s a good idea, but there isn’t anything inherently silly about it. But as I understand it, that’s not what Professor Taylor has advocated for the past 25 years.
    He seems to advocate using the full Taylor rule, using it in a form that is entirely backward-looking, and using parameters dictated to John Taylor directly by the Almighty. And since the Almighty is also All-knowing, those parameters of course produce a better policy than would any other set of parameters. (When I say “parameters,” I’m referring to 3 things: the coefficients on the Taylor rule terms; the figure for potential output — or for the NAIRU — used to calculate the output/employment gap, which is not a simple matter to ascertain; and the target inflation rate.) But what are we to do after John Taylor is dead? Who will then tell us the correct parameters for the Taylor rule? Or will he on his deathbed tell us what the true inflation target should be for all Eternity?
    I would suggest that Professor Taylor is actually being very “un-Taylorian” in presenting that evidence about commodity prices. Perhaps he’s giving lip service his younger self, but for practical purposes, he’s abandoning the Taylor rule entirely and saying that asset bubbles are more important than either price stability or output stability. Well, OK, he’s saying that asset bubbles are important because they can cause prices and output to become unstable, but he’s saying — in the case of this particular asset bubble in commodity prices, since in retrospect it clearly was a bubble — it is the bubble, and not the price and output (or unemployment) data that goes into the traditional Taylor rule, that should have concerned the Fed.
    There is a case to be made for that point of view, but personally I’ll stick with the younger John Taylor as against the older one.

  4. Michael Krause

    If your summary is correct (as I haven’t yet opened the paper), this whole paper of his is an exercise in faulty attribution of causation. Looking back we can create all sorts of arbitrary correlations, but it is useless and will be shortly forgotten.
    You can attribute the credit bubble to any sort of things, but to me it is most obvious a combination of improper assessment of risk due to the same disease in this paper: looking to the recent past to come to faulty conclusions about the future.
    Even respected economists such as Taylor prove to be just trend followers blind to common sense or externalities.
    Interest rate policy is just one part of this. Another is crude and natural resource stockpiling of China (and the subsequent crash in demand) pre-Olympics – that event was a result of politics and pride, not interest rate policy.
    .. I need to actually read the paper.

  5. anon

    Good to see the nonsense of the global savings glut being discredited here – the Fed`s (Greenspan – Bernanke) favourate anti-rationalization should always be exposed for what it is.

  6. algernon

    I agree with anon that discrediting the ‘savings glut’ notion is worthwhile. Foreign central banks buying US & European long-term debt with freshly created Yen, Yuan, et al–to a large extent unsterilized–is not my idea of savings…even if it is eventually taken out of the hides of Chinese, Saudis, et al as domestic inflation.
    How anyone can deny the importance of the incredibly & artificially depressed interest rates in causing the present crisis escapes me. The easy money(an understatement) was the sine qua non of the stupid decisions of lenders & borrowers. Admittedly, laxness by the SEC/Fannie/Freddie & over-confidence generated by securitization greatly exxagerated the credit bubble. But you’ve got to put yourself in the place of the negligent lenders responding to the lure of super easy money: you don’t make any money if you don’t get it lent out. They were in a frenzied competition to do so.
    My use of the term artificial above is considered. As Taylor points out, savings declined. So did interest rates. At a time when investment in housing in the US, UK, Spain; big gov’t in Europe; & manufacturing in China were all burgeoning. Only one way that happens.

  7. smg

    What difference would it have made if the Fed increased interest rates in 2002 as opposed to 2004?
    What I have in mind is the discussions about the yield curve taking place on this blog during the Spring of 2007. The issue being that that though short term rates were rising after 2004, long-term rates (such as the 10 year Treasury) were not budging. If one believes that this was in part due to our trade deficit, then it is not so clear that long-term rates would have risen back then. I’m under the assumption that housing depends on long-term interest rates, not short-term.
    What am I missing?

  8. David Pearson

    JDH,
    Sure regulators aided the artificial inflation of house prices by allowing shoddy lending to occur. Its hard to argue with that view. However, surely you owe us some explanation of how they should have acted differently when the Fed, economists, market participants, and virtually everyone around them argued that nominal house prices never fall. In fact, Greenspan himself, in testimony before Congress, argued that California mortgages were LESS RISKY because the rapid home price appreciation (i.e. the bubble) meant that borrowers had plenty of equity cushion in their homes. Think about the implications of that statement. You could summarize it as, “the bigger the bubble, the safer the mortgage.” Really, it should go down as one of the more irresponsible statements ever made by a Central Banker.
    So, the question is, what, exactly, should regulators at the OTS, the FDIC, and yes, the Fed rank-and-file, have done differently? Ignore mainstream economists? Go against the Fed Chairman (commit career suicide)? Ditch their bell-curve econometric models of defaults? Reduce bank profitability by insisting on reserve and capital levels that had no basis or grounding in academically-accepted empirical analysis?
    I would argue that regulators were at fault for not exercising common sense. However, I certainly wouldn’t single them out for that shortcoming. You could just as easily point fingers at thought leaders (hint: economists) that did not challenge commonly-held views. Views that obviously, at the time, made no sense.

  9. fernando

    The FED doesnt drive commodity prices. If the market decides to bid oil to nonsensical levels because of fed policy and not supply and demand its the market who gets the blame, NOT THE FED. only a biased economist with an agenda like Taylor would suggest something like that

  10. Counterpole

    The FED is a huge fraud! How could you have a savings glut? From the FED’s point of view, savings deposited in a bank are a liability. A loan from a bank on the other hand is an asset. The FED wants assets, not liabilities, so they tell us that we need to borrow and spend. What a crock!
    Whoever saves and invests will grow and prosper.
    Whoever borrows and spends will wither away.
    Abolish the the FED and go back on the gold standard.
    db

  11. george Fountas

    The federal power to issue paper money was STRIPPED out of the US Constitution during the Constitutional Convention on a vote of 9 to 2 after the Continental currency fiasco during the Revolutionary War.
    One of those voters went so far as to comment that the power to print money was an abomination similar to the “Beast of Revelations”
    Another stated he would rather have the whole project (forging a Constition) come to nothing if that power was included.
    I leave the reader to decide if someone STRIPPED of a power has the authority to give it back to himself.

  12. Jeff

    Jim,

    In line with your comment that inadequate regulation is partly to blame for the mess, you might look at some of Bill Black’s work on control frauds. See, for example, this essay at Cato Unbound and this followup. Black is a former regulator with deep experience in the S&L crisis, and he sees a lot of parallels in the currrent environment. If he is correct (and I think he is) that many of the denizens of Wall Street are sophisticated control frauds, the correct policy response is very different from what we’ve seen. We should be burning the bondholders and putting a lot of CEO’s in jail, not bailing them out. As Willem Buiter says so often, now is always the right time to deal with moral hazard.

  13. Renee

    He missed the bigger question, “Is it time to abolish the Fed” The fiat money system of booms and busts is not working. It’s time to return to sound money.

  14. kharris

    I think Taylor may have left some room in his analysis to agree with your view that there was a regulatory factor -
    “…the interbank market was not a liquidity problem of the kind that could be alleviated simply by central bank liquidity tools. Rather it was inherently a counterparty risk issue, which linked back to the underlying cause of the financial crisis.”
    One could argue that easy policy lured banks into bad underwriting and bad investment behavior, leaving out regulatory oversight, but this distinction between liquidity and risk fits with your regulatory view.
    smg’s point is well taken. If there were no savings glut, then there was a conumdrum. One way or another, the shape of the curve in the 2002-2004 period needs to be addressed if one is assigning blame for the housing boom.
    When it comes to the commodity price rise in early 2008, wasn’t there also a commodity price rise in 2007, after the Fed had tightened? If the observation that the Fed may have contributed to high commodity prices is nothing more than an observation, then it is probably true enough. If is a condemnation, then kznz’s critique is a good one. If the Fed, at its best, looks ahead to what’s coming rather than relying on what has passed, then easing early in 2008 was the right policy. We have disinflation now, when there is some hope rate cuts a year ago can have an effect. That’s pretty good shooting.
    In the end, the Fed probably was too accommodative for too long. We should learn from that. What we don’t know, however, is what the counterfactual would have looked like. If Taylor is doing no more than to demand a Taylor-ruled based monetary policy, then I wish him a long life. Milton Friedman lived long enough to admit that his rule-based approach to monetary policy was mistaken, and there seems good reason to think Taylor would reach a similar conclusion, given time.

  15. Skptk

    The Fed also aggravated the bubble by other means besides rate cuts. Whenever the stock market started to correct on its way up from 2003, they would goose it with injections of capital to the Wall Street biggies. The injections kept getting bigger and bigger because the further along they got the less effective they were. You guessed right that they reached a point where they no longer worked and the market dived. Now they are injecting 5x plus the amount they did at the market’s height and they can’t stop the downward trend. You can track these numbers on the NY Fed’s website or easier at “The Slosh Report”. Abolish the Fed!

  16. K

    Amen to abolishing the Fed. I was always amazed that the general population actually believed that something so complex and interconnected as our economy could be controlled from a board room with one tiny interest rate. What an absurd notion.
    The Fed, however, is perpetually late to the game, and always overdoes it. Their new policy experiments of 2008 have not worked, and arguably have made things worse. Why is central planning in the case of our money supply NOT a bad thing – when it has proven to be a horrible idea everywhere else?
    A self-regulating money supply backed by gold, with strict regulations on acceptable collateral, discounting, reserves, etc. is a better alternative. The debate is never allowed to occur, though.

  17. ronmexico

    Doesn’t this article seem sloppy to anyone? For example,
    [1] He doesn’t have standard errors for his simulations in Figure 2. If you regress housing starts on interest rates, the fit would be horrible. So, I’d bet that the standard errors would be wide enough so that you wouldn’t be able to distinguish between the “boom” and “bust” lines.
    [2] In figure 9, he plots the Libor-OIS spread against the TAF, and says the chart implies that the TAF did nothing. How does he know that the spread wouldn’t have been HIGHER were it not for the TAF? When I’m in a car, I can keep my speed constant going uphill by pressing down on the accelerator. Taylor would regress car speed on accelerator pressure and conclude that the accelerator has no effect on the car’s speed.
    [3] In figure 10, he says that disposable income went up, but PCE didn’t, so the stimulus checks had no effect. Shouldn’t he mention the fact that gasoline prices were ripping at this time, and they played a big role in offsetting the stimulus?
    [4] Around Figure 11, he says low interest rates drove up oil prices, and although they’ve been falling because the global economy is melting, the damage has been done. The Fed thought the economy was in serious trouble, so it cut rates agressively. If the market had had the Fed’s (correct) view, then oil prices wouldn’t have rallied. Is he blaming the Fed for getting the story right? Plus, how can he say that “the damage … has been done”? Since 2007, oil prices rose by $80 and then fell by $95. If 95 > 80, that’s net stimulative.

  18. Hitchhiker

    I love the post. Did anyone else see the historical documentary on the History channel Sat night about the Depression of 2008, where the cause could be put at the feet of Phil Gramm, George Bush, and the concept of deregulation? They talked about things that happened a few weeks ago as though it was ancient history and documented fact. The audacity frankly astounded me. The timing also. In how short a period of time can something be produced for that channel?

  19. DickF

    Thanks Professor. I read the paper this morning and thought it would be a good post for econbrowser. Don’t agree with everything but it is good to see so many economists beginning to come around moving closer to the right answers.

  20. wally

    “we ask too much of monetary policy”
    I lot of this, we did not ask for. Bernanke jumped in and assumed responsibilities he should not have taken on. Once he did so, continuation was expected. (beyond that – I agree with most of what Taylor says; the Fed and Treasury are really mucking around in this mess with no idea what they are doing. Bernanke is re-fighting the last great economic battle and Paulson has a crony-centric world view).

  21. oops

    o.k. can someone explain to a non-economist where i’m wrong here:
    the fed was too stimulative but rates were absurdly low even in 10yr treasuries, yet there was no savings glut. don’t you still have come to grips with the fact that even with the fed keeping rates so low there was a lot of money being lent rather cheaply
    when tyler cowen wrote in the nyt about the asian savings he pointed out that ecb rates were not too low

  22. Mike Laird

    JDH, thanks for publishing this and stimulating a discussion. I agree with your comments that the Fed “tried too hard” to achieve several steering moves of the economy. I don’t believe a small group of people with a relatively small amount of funding (compared to global market forces) can steer the US economy. The mission objectives that charter the Fed to maintain full employment and manage the economy should be removed from the Fed’s charter. They have more than enough to do to ensure a sound financial system. They did not do this job well in the past 4+ years, and they have many more challenges to sound finance coming up. If the Fed could provide a sound and globally competitive financial system, market mechanisms and occasional fiscal stimulus would provide an attractive growth economy. We should get the Fed out of activities that they cannot do well.

  23. Anantha Nageswaran

    Real short-term interest rates computed using ex-post CPI inflation in the US remained below their two-decade average for three years between 2002 and 2004. Given the enormous pressure for dollar depreciation that it induced from 2002 onwards, other countries cut interest rates too aggressively, ECB included. Consequently, real short interest rates were below historical averages in the US, Eurozone, Switzerland and Japan between 2002 and 2004.
    Thus the Fed triggered easy money everywhere with its ‘too loose for too long’ monetary policy.
    Second, its insistence on reckoning with asset prices on their way down but not on the way up was an additional contributor to the easy monetary policy.
    Given very slow and modest rate of wage growth, the near doubling of home prices was a bubble that went unrecognised because of this asymmetric framework.
    Then comes the role of inadequate or no regulation, the role of credit-rating agencies, etc.

  24. killben

    “I would instead point to inadequate regulation of key financial institutions as the single most important factor that brought us where we are today”
    Bulls Eye! … so who is to be blamed..
    Fed, Treasury & US Govt have misread the situation consistently, ensuring they were always behind the curve and when it was time to act, mishandled the whole stuff …
    The shielding of big institutions and the the theory of being too big to fail is being carried to such an extreme that credit is being starved to small institutions and the velocity of money has been dampened to such an extent that big and small are going to drown one for bad lending and other for lack of capital
    when will these guys learn that cleaning up means removing the garbage and not something to be swept under the carpet and kicked down the road…
    till institutions are asked to own up, sell pieces of themselves, fail etc .. taxpayers are going to have a huge bill with no return except some lip service … it is next to impossible that this is going to be sorted out without admiting the crap in the balance sheet for what it is .. till then these guys will enjoy their bonus while taxpayers foot the bill … tax revolt is in the offing if this craze for splurging tax payers money continues .. why can’t you get the bonuses paid .. adds to billions of dollars and use it to bail these banks out

  25. John B Taylor

    Thanks very much to Professor Hamilton for posting my paper and for stimulating such a good discussion. Though the title of the post mentions only the Fed, my paper also raises questions about fiscal policy decisions (the temporary rebates), implementation of policy by the Administration (the lack of clarity in the operation of the TARP), and regulatory policy (the failure to rein in Fannie and Freddie). The last of these is an example of regulatory failure, and I completely agree here with the analysis in the Hamilton 2007 Jackson Hole paper.
    Here are some other comments:
    Tim: The Total TAF balance in Figure 9 includes the dollar loan auctions at other central banks in addition to the Fed TAF balance. GK,1: As I mention in the paper, the fall in oil prices in the period beyond the data plotted in Figure 10 was very likely due to the sharp decline in the world economy and the deteriorating future outlook. In my view the IMF staff research I referred to controls for such effects using multivariate methods in ways that are difficult to include in a graph. GK,2: If you take the funds rate down to 1 but then raise it more rapidly than in Figure 1 you get very similar results as in Figure 2. So I think my results are robust to your alternative counterfactual, which seems like a reasonable alternative. KNZN: I did not say that the Fed should not have cut rates in the first 6 months of the crisis, but I do think that the rate came down too much and too rapidly during that period and that is why I used it as an example. You get very similar results if you use blue chip forecasts for inflation and output at the time, but, in any case, I do not think it is silly to use current values in the policy rule. First, that is how the rule was first evaluated. It builds in the lags that you mention. Second, the current values are effectively forecasts because the Fed always has to forecast (nowcast) where we are. I am not arguing that you should put asset prices in the Taylor rule. I do not think that is a good idea. The Fed was too low in 2002-2004 even without asset prices. MICHAEL KRAUSE: I agree with you about the dangers of falsely attributing causation to correlation, especially with the passage of time. Using explicit counterfactuals with models, as I have tried to do when possible, helps prevent this. Also much of the work underlying this paper was done in real time without the advantage of hindsight. SMG: Housing also depends on short rates, because of ARMs. I think the long rate problem was due to holding short rates down for too long, which affected expectations of future short rates.
    RONMEXICO: 1. The estimated regression coefficients of housing starts on the federal funds rate are very significant. 2. Figure 9 is an illustration; in my paper with John Williams we control for other factors using multivariate regressions. 3. I have tried to add oil prices to regression tests of the rebate, but the impact of the rebate on consumption remains insignificant. 4. The point here is that rates were cut by more than the policy rule.

  26. RebelEconomist

    If the Fed had been concerned earlier this decade that the level of long term interest rates was being reduced undesirably by a “saving glut”, it was within its power to directly do something about it. The Fed could have sold the longer term treasuries from its SOMA portfolio and supplied base money via short term repurchase operations like the ECB instead of using coupon pass operations. At the time, the Fed itself was probably the world’s largest central bank holder of treasuries rather than the BoJ or the PBoC (“probably” because neither country publishes details of its reserves holdings), with holdings across the yield curve. As we have seen from the recent expansion of its balance sheet, the Fed is capable of doing large volumes of short term operations if necessary. Unfortunately though, the Fed has proved more innovative in using the asset side of its balance sheet when easing than when tightening.

  27. flow5

    Taylor, your a dinosaur. The money supply can never be managed by any attempt to control the cost of credit.
    Your analysis is looking through the rearview mirror. It is absolutely impossible to miss an economic forecast. See Dr. Leland James Pritchard, Ph.D., Economics, Chicago 1933, M.S. Statistics, Syracuse.

  28. plusaf

    i knew that greenspan kept the prime too low too long and that every time he or bernanke opened their mouths, they said something stupid that panicked the stock market.
    then poulson came along with a “solution” on the back of a napkin with infinite power and no limitations for himself.
    as if we are ALL morons out here.
    http://www.youtube.com/results?search_query=jim+rogers&search_type= is a great source, but unless Obama is open to some of Jim’s ideas, i think a lot of people will be doomed to a really crappy life for the next decade or two.
    unfortunately, that also approximates my life expectancy.
    thanks, all you ego-driven, power-mad fools in Congress.

  29. flow5

    Oh yeah, interest rates are “binding” but legal reserves are not?
    It is literally impossible to miss an economic forecast using bank debits. And there were a number of forecasters, that used a number of rates-of-change, that accurately measured nominal GNP. But there are no academic papers covering bank debits.
    And contrary to every single economic forecaster, indeed every single economist, all economic lags (monetary flows – i.e., the rate-of-change in the volume of money times its rate of turnover) have exactly the same lengths.
    And because these monetary lags (MVt) are identical, economic forecasts become ex-ante, and not ex-post, as in the Taylor Rule.

  30. flow5

    Proof? No one studied bank debits:
    How so? There were large reporting errors, viz, all the demand drafts drawn on these institutions* cleared through DDs except those drawn on MSBs, interbank, and the U.S. government.
    1) MSB balances in the commercial banks (CBs) were designated as interbank demand deposits (IBDDs) presumably because MSBs are call banks.
    MSBs HAD ALWAYS BEEN, and were intermediary financial institutions intermediary between saver and borrower.
    *The Depository Institutions Deregulation and Monetary Control Act (DIDMCA), by legalizing the use of the NOW type of checking accounts by (1) Savings and Loans (S&Ls), (2) Credit Unions (CUs) and (3) Mutual Savings Banks (MSBs) immensely accelerated the rise in Vt, as did the introduction of (4) money market funds (MMFs).
    Note: the rate of growth in the transactions velocity of money hit it’s maturity in the 80′s.

  31. sam nemazie

    One argument of Professor Taylor, is that there was not a liquidity problem but risky asset
    It can be argued that risky assets will result in liquidity problems. That is Market avoiding such risky assets or putting a high premium on such assets will cause a liquidity problem for holders of such assets
    The argument should not be that there was no liquidity effect, but that the cause of such liquidity effect was risky assets and the Fed was attacking symptom
    Certainly the Fed can attack the symptom i.e. the liquidity problem, but how the Fed could have taken steps to reduce the risk of such assets
    Professor Taylor argues that lack of a consistent policy (no matter if you agree or disagree with policy) dealing with troubled institutions aggravated the situation out of control in September time frame. What determines if Fed is going to help one institution and let another fail?
    Professor Taylor argues that letting Lehman fail was not a factor in crisis that started in September. Here the Professor is not consistent with the above argument. One can argue that prior to September; there was an understanding that that Fed will not let a big institution fail. However the Fed broke that rule when it allowed Lehman to fail and the Market paniced (with a lag of 1 week)! Who is next? Will Fed let Citi also fail? The Market continued to fall until the deal to bail out Citi was announced (that was the low of Market, so far)

  32. Mike

    As a long time mathematician, and reviewer of studies based on “junk correlation”, Taylors work is nothing more than empirical studies that attempt to fix causation from correlation. Its nonsense.

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