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During a March 31 visit to the Kellogg School, John B. Taylor discussed the challenge of setting monetary policy and the tools used to do so.

Noted macroeconomist John B. Taylor visits Kellogg School

Scholar and former Treasury undersecretary tells how public policy and academic insights mix

By Matt Golosinski

4/2/2008 - The inspiration for the “Taylor Rule,”a widely used calculation that guides the monetary policy of central banks as they set short-term interest rates, delivered a lecture to a standing-room-only audience at the Kellogg School on March 31.

John Taylor
Economist John B. Taylor, Treasury undersecretary for international affairs from 2001 until 2005, discussed “the explanatory power of monetary policy rules.” The talk explored the intersection of academic theory and public policy with respect to how the Federal Reserve sets interest rates given factors that include inflation and GDP gap — the difference between actual gross domestic product and the potential output. Taylor’s work has been instrumental in helping create and refine the analytical tools to offer better understanding of the dynamics associated with setting monetary policy.

The Mary and Robert Raymond Professor of Economics at Stanford University and a senior fellow at the Hoover Institution, Taylor said his interests have included examining “the scientific social research aspects of monetary policy rules” in a way that enhances the predictive ability of tools like the Taylor Rule. He traced the academic and policy origins of recent monetary theory and practice, reflecting on how economists previously understood and approached the subject.

Between 1965 and 1979, for example, Taylor said that the Federal Reserve operated using an analytical framework that proved considerably less effective in taming inflation and spurring growth. In fact, “the response was half as large as today,” he noted, referring to coefficients associated with the inflation and GDP gap figures that are part of the Taylor Rule.

More recently, he said, policymakers have taken a more aggressive approach to curbing inflation, with dramatically better results. “Even the downturns [now] tend to be more moderate,” he said.

Taylor credited advances in how economists understand and implement monetary policy with an overall improvement in the economy in the last 25 years. While admitting that some continue to debate the point, he also said the Federal Reserve’s shift in policy in recent decades has resulted in a general moderation of GDP growth volatility. “Most amazing of all,” he added, is that the positive effects of this monetary policy shift do not seem confined to the United States, but appear to work in many other countries too.

In introducing the speaker, Charles Manski, Board of Trustees Professor and chair of the Northwestern Economics Department, said that Taylor has made “enormous contributions to monetary policy.” Lawrence Christiano, the Alfred W. Chase Professor of Economics at Northwestern, added: “John’s work on labor contracts is seminal and led to a huge burst of creative work. The Taylor Rule has launched several literatures in the field.”

The author of Global Financial Warriors, a text detailing his efforts at the U.S. Treasury to fight terrorism in the aftermath of the Sept. 11, 2001, attacks, Taylor appeared at the Kellogg School as the inaugural speaker in the Susan Bies Lecture on Economic and Public Policy. Bies, who earned her doctorate in economics from Northwestern University in 1972, has served in various capacities during a long career, including on the Board of Governors of the Federal Reserve System from 2001 until 2007.