Economy & Business

The Corner

Time for a New Fed Chairman

The establishment is pulling out all the stops to demand that President Trump reappoint Janet Yellen as Federal Reserve chair. But a new chair of the Federal Reserve would help take the central bank in a direction that helps the economy.

One of the problems of Janet Yellen’s time as chair has been that huge amounts of business time and energy have been devoted to reading the tea leaves before each and every Fed meeting: Will she or won’t she raise interest rates? What is the Fed going to do about its huge pile of assets? The economy would be helped by less speculation and more certainty about what path the Fed will take.

That’s why a so-called “maverick” choice, such as John Taylor of Stanford University, would be better for the economy. What the Fed really needs is more rules about how it will handle its responsibilities — and Taylor is well known for the “Taylor Rule,” which adjusts interest rates counter-cyclically. That is, under the Taylor Rule, the Fed raises interest rates when the economy is possibly overheating (for instance, when inflation is high) and lowers rates if the economy looks like it’s cooling down.

What is important is not the exact form of the rule (there are other options besides the Taylor rule), but that it is predictable. The bank has a rule and follows it, in good times and in bad, regardless of political pressure. This is essentially how the Fed operated under Paul Volcker, Fed chair under Presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987. That predictable behavior made possible a huge increase in living standards.

Predictability is crucial because it keeps the price system honest. Entrepreneurs can make long-term plans knowing that the Fed isn’t going to freak out during a crisis and willy-nilly change course. They don’t have to build in unnecessary hedges against policy changes (costing them, their employees, and their customers more) or suddenly change their business practices, possibly laying off staff or shocking their customers.

It is ironic that economists such as Taylor who promote such predictability as a virtue are the ones nowadays described as mavericks. America’s entrepreneurs and businesses urgently need more stable government policies that encourage economic growth. A move to a rules-based Fed under a chair who can guarantee the Fed is going to stick to the rules will be good for the Fed, good for the economy, and good for America.

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