Working Paper: CEPR ID: DP17981
Authors: Alex Cukierman
Abstract: This paper shows that, in the face of the recent return of inflation, the Fed failed to follow Taylor’s principle as prescribed by conventional monetary policy. In particular, the Fed did not raise the policy rate by enough in the face of rising inflation. The paper discusses the reasons underlying this policy choice and classifies them into temporary and longer term. Temporary considerations, such as a belief that inflation is temporary are likely to fade away over time. Longer term effects, such as regulatory reform during the global financial crisis (GFC) and a persistently high Debt/GDP ratio inherited from the GFC and the pandemic are likely to affect Fed’s policy for quite a while in the future. The paper evaluates the extent to which this change in policy is desirable and concludes, in view of the longer term effects, that it is. Similar considerations apply to other major central banks such as the ECB and the Bank of England.
Keywords: violations of taylors principle; inflation; policy rates in aftermath of pandemic and gfc; regulatory reform; debt overhang
JEL Codes: E5; E4; E3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Insufficient policy rate increases (E64) | Higher inflation rates (E31) |
| Rising inflation (E31) | Decrease in ex-ante real FFR (E43) |
| Temporary beliefs about inflation being transitory (E32) | Deviations from TP (F12) |
| Regulatory reforms from GFC (G18) | Deviations from TP (F12) |
| High debt-to-GDP ratio (H69) | Deviations from TP (F12) |