John Taylor on monetary policy over the last decade

John Taylor, the creator of the Taylor Rule for analyzing monetary policy, provides some good insights into the policy choices of the last ten years in the May American Economic Review. His main argument is that monetary, fiscal, and regulatory policy became more discretionary, interventionist and less predictable during the years preceding the Great Recession. This change in behavior could have been a contributor to the recession and the poor recovery. 

Monetary policy showed a shift away from the Taylor Rule and was moved to unusually low levels prior to the Great Recession. During the 2003-05 period, rates were lowered in response to deflation fears but the impact was the housing boom and speculative excess. This excessively low rates were a contributor to the excessive housing prices and lending binge through the use of adjustable rate and subprime mortgages. This discretionary behavior continued with the flow of liquidity during the panic of 2008 which was clearly necessary, but also continued during the post recession period. The QE policies are without precedent and has provided a higher level of uncertainty.

Regulatory policy was uncertain during this period. The "largely ad hoc bailout policies"  with respect to Lehman and other firms certainly added to market uncertainty. The TARP plan and other forms of government lending has also created a mixed view of what actual action will be taken in a crisis. There have been good actions taken, but there has been a change in the regulatory landscape which creates a lack of clarity on what will be done in a crisis or under normal times.

Discretionary fiscal policy has also been more uncertain with unclear objections on what should be the goals of policy. Given the current labor environment, it is not clear what are the fiscal policies in place to improve employment.

Fighting the story of poor policy choices, are two alternative stories: one, the weak recovery following deep recessions from a financial crisis hypothesis, and two, the secular decline in equilibrium real interest rates. The first hypothesis is based on the reading of history that financial recessions take a long-time grow out of. The evidence here is mixed. The second hypothesis on secular stagnation argues that the excess of savings versus investment has pushed equilibrium real rates negative. Given the zero bound, the negative real rates can only be realized if there is higher inflation. This story does not seem to be consistent with the historic facts. Hence, the discretionary monetary policy is still a contributor to the economic problems of the last decade.