Political economy is the science of managing a nation´s resources so as to generate wealth. As such, policy is never predetermined but is always data dependent. Not a single, unified approach, but a family of approaches. Many of the issues of concern to political economy are themselves a subject of study, because politics also becomes the subject of political economy, and institutions are no longer ignored. All of this is tied together by a set of methodologies, typically associated with economics.
Economic history, when all is said and done, is economics applied to old data. But that is easier said and done. “Data”, as its name belies, isn´t given but made, extracted and constructed, and it is advisable to know from what context and by what methods.
– Keeping in mind the all-important proviso that policy is never predetermined but is always data dependent, what can we say about the appropriate path of policy, assuming the most likely outcomes for real activity, inflation, and related factors? Recent Speech given by Fed chairwomen Janet Yellen at the “The New Normal Monetary Policy,” a research conference sponsored by the Federal Reserve Bank of San Francisco, March 27, 2015, deal with this question and discuss some factors of the Taylor´s rule.
The Taylor rule has become a staple of monetary theory.
It replaced the ancient Phillips curve trade-off between the unemployment rate and the inflation rate. While the Phillips trade-off could only be temporary, the Taylor trade-off was claimed to be permanent. According to the speech: Taylor’s rule now calls for the federal funds rate to be well above zero if the unemployment rate is currently judged to be close to its normal longer-run level.
Under normal circumstances, simple monetary policy rules, such as the one proposed by John Taylor, could help us decide when to raise the federal funds rate. The “normal” level of the real federal funds rate is currently close to its historical average.
Few economists have experienced the honor of seeing their name associated with a law or basic principle during their lifetime. Lucas and Taylor are members of this small club, the first for the ‘Lucas critique’, the second for the ‘Taylor rule’. paper, by Stanford University economist John Taylor. The “Taylor rule” he proposed in the early 1990s is a formula that stipulates what the Fed’s benchmark rate should be based on inflation and the level of economic growth. It’s now a model for a House bill that would force the Fed to base its interest rate decisions on a rule.
However, the Fed don’t have to always stick to it. In such case, they just have to give the reason…..simple rules are, well, too simple, and ignore important complexities of the current situation, about which she have more to say here.(see more Fed chair Janet Yellen´s Speech advocating peaceful methods to begin adjusting policy).