So apparently President Trump asked for a show of hands at a Senate lunch on whether he should choose Jerome Powell or John Taylor as the next Fed chief, and Taylor won.
Mr. Taylor, of the eponymous Taylor Rule, is loved by many on the right. But he would be a disaster as Fed chair. As Hayek told us in his Nobel Prize lecture, economics is not physics, and economists looking for mathematical precision are suffering from the mere pretense of knowledge.
As the following chart shows, the Taylor Rule would have been a huge policy mistake if followed post 2008. The red line is the actual Fed Funds rate, and the blue line is the rate implied by the Taylor Rule.
As disappointing as the economic recovery has been post Financial Crisis, it is certainly better than no recovery at all. Which is what we would likely have if Mr. Taylor’s Rule had been followed from the bottom of the Great Recession.
The Taylor Rule would have the Fed Funds rate at about 3.5% currently, versus the actual range of 1% to 1.25%. This would invert the yield curve and likely send us into a needless and destructive recession.
The economy and stock market have been doing well under President Trump thus far. Reduction in regulation and potential tax cuts are helpful. But selecting Mr. Taylor, who would raise interest rates to respond to his mechanical rule, would tank all of this progress for no good reason. Ditto for Kevin Warsh, although to perhaps a lesser extent.
Yellen has done a good job and should be reappointed, but Powell would be a good choice for a replacement. They seem to understand our current moment with demographic headwinds and an absence of inflation in the data. Appointing Taylor now runs the risk of a repeat of the misguided 1937 tightening that caused the infamous recession within the Depression. That is a policy mistake we can’t afford.
Hopefully, common sense will prevail and Yellen or Powell will be the choice. If not, recession odds will go way up.
“It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.”
— Charlie Munger