DP17981 Recent violations of Taylor’s principle by the Fed: Documentation, reasons and relevance for the future
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.