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Source link: http://archive.mises.org/9102/john-taylor-blame-the-fed/

John Taylor: Blame the Fed

December 15, 2008 by

Blame the Fed. (pdf) From the conclusion:

In this paper I have provided empirical evidence that government actions and interventions caused, prolonged, and worsened the financial crisis. They caused it by deviating from historical precedents and principles for setting interest rates, which had worked well for 20 years. They prolonged it by misdiagnosing the problems in the bank credit markets and thereby responding inappropriately by focusing on liquidity rather than risk. They made it worse by providing support for certain financial institutions and their creditors but not others in an ad hoc way without a clear and understandable framework. While other factors were certainly at play, these government actions should be first on the list of answers to the question of what went wrong.

{ 4 comments }

Adam Frost December 15, 2008 at 2:05 am

I haven’t yet taken the time to read the whole thing, but just from looking at the quote, would I be correct in thinking that the gist of what is being said is the mainstream belief that the intervention of the fed and the government was simply poorly run and failed as a result, as opposed to the reality that government intervention by it’s very nature leads to crises such as the current one?

Grant December 15, 2008 at 3:39 am

Well, I read the whole thing. I think it probably has some flaws, but not being an economist I’m not sure I could accurately point them out. It was still very informative.

It was written by the creator of the Taylor rule, so naturally the author argues in favor of his creation. He gives some empirical evidence that deviation from the Taylor rule caused the crisis, but provides causal explanations as to how. He also shows how other central banks around the world deviated in a similar fashion as the Fed, and the crisis tended to be worse in countries with more deviation.

He claims the savings glut explanation is false, citing IMF data that shows worldwide savings to be dropping since 1970. This strikes me as rather simplistic – I would think proponents of the excess savings cause would have already answered such a criticism?

Taylor does show, quite convincingly, that the crisis was not one of liquidity, but one of uncertainty and risk (by looking at government-backed interbank loans and comparing them to non-backed loans). He also stresses the regulatory uncertainty during the bailout process, and how that likely contributed to the problem. I think that point often does understated.

Adam, I think that is beyond the scope of the paper. The questions “should we have a Fed, and if so what should it do?” and “we have a Fed, what should it do?” are very different and require very different arguments to answer. Support for good policy over bad is not the same as support for intervention over markets, and most economists assume the existence of our current institutional framework (or something similar to it). The paper does a good job of showing that recent policy has been terrible.

Black Bloke December 15, 2008 at 4:50 am

…of Caroline?

Chee Heong Quah, MYS July 11, 2009 at 10:24 am

Absolutely agree.

As been put up by Milton Friedman before, the Fed should be removed and let the supply of funds and liquidity determined by the market.

Only that moral hazards and excessive risk-taking by bank and pseudo-bank executives can be contained.

A libertarian.

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