John Taylor on Rules, Discretion, and First Principles
What this covers
John Taylor of Stanford's Hoover Institution joins Russ Roberts to defend the case for rules-based economic policy against discretionary intervention. The conversation ranges across five decades of American monetary and fiscal policy, arguing that prosperity correlates with adherence to first principles—predictability, rule of law, reliance on markets, incentives, and limited government—while periods of discretionary activism have produced stagflation, recessions, and deteriorating economic conditions. Taylor illustrates this pattern through a historical arc: the stagflation of the late 1960s and 1970s, the relatively prosperous 1980s and 1990s under more rules-oriented approaches, the 2003–2005 deviation from steady monetary policy, and the financial crisis that followed.
The conversation emphasizes monetary policy as the lever most often misused. Taylor traces how Lyndon Baines Johnson and Federal Reserve Chair Arthur Burns financed Vietnam War spending without raising taxes, how richard nixon imposed wage and price controls to avoid the political pain of disinflation, and how Burns implemented a go-stop policy that ratcheted inflation upward across successive cycles. By contrast, Ronald Reagan's willingness to support Federal Reserve Chairman Paul Volcker through the 1982 recession demonstrates how political support for rules can work. The discussion also covers quantitative easing, the 2000 removal of the Federal Reserve Act's requirement that the Fed report money-growth plans, and why temporary interventions—tax rebates, home-buying programs, cash-for-clunkers—show little academic support yet persist. On fiscal policy, Taylor argues that the [debt-to-GDP ratio](jargon:debt-to-GDP ratio) explosion is best addressed by constraining spending growth rather than raising taxes, and that entitlements spending accelerates beyond demographics alone. The closing discussion considers whether policy will shift after the 2012 election.
Taylor argues that economic prosperity follows from policy that adheres to first principles—predictability, rule of law, reliance on markets, incentives, and limited government—and that rules-based policy (especially monetary policy) outperforms discretionary intervention, as the history of the last half-century demonstrates.
- Discretionary, interventionist periods (late 1960s-70s) produced stagflation while rules-based periods (1980s-90s) produced prosperity
- Monetary policy is the most important and most often discretionary lever, and recent deviations contributed to the financial crisis
- The exploding debt-to-GDP ratio is best fixed by holding spending growth to roughly 2007 shares of GDP rather than raising taxes
Temporary, uncertain interventions proliferate despite little academic support from either political direction.
- Despite the Fed's unprecedented creation of reserves on bank balance sheets through QE, the intervention had little impact partly because the Fed encouraged the reserves to sit on the books by paying interest on them; the Fed's own rationale focuses on what they did with the money (lowering mortgage and medium-term Treasury rates) rather than the money creation, and believes it can unwind the balance sheet in time—a belief many, including Taylor, doubt.
“despite the enormous creation of reserves through the Fed on the balance sheet in the banks... it hasn't done very much. Partly because they've encouraged it somewhat to sit on the books via paying interest on it.”
- Across the last three and a half decades there have been a striking number of temporary interventions (tax rebates, home-buying programs, cash-for-clunkers) that, when evaluated individually with more precision than broad trends allow, have remarkably little academic support from either left or right—yet they keep happening, suggesting something beyond economic research drives them.
“there's remarkably little evidence to support any of these programs, from left or right. And yet they keep happening.”
- Despite his intellectual past and relationship with Ayn Rand that made him appear a near-anarchist, Greenspan's rhetoric did not match his actions once near Washington—he repeatedly deviated from free-market principles, including supporting the 1995 Mexican rescue he testified was a bad idea but had to be done anyway, and endorsing a temporary tax rebate.
“when he got near Washington, D.C., his rhetoric didn't quite match his actions... many, many times he deviated from what we would call free market principles. In this case he was more of a Keynesian than he perhaps felt in his heart”
Sound free-market principles can lie dormant for decades before adoption, offering long-term hope despite short-term setbacks.
- Sound economic ideas like those in Friedman's Capitalism and Freedom can sit ignored for years—even appearing crazy or kooky—before becoming mainstream and being adopted, so there is always hope that the policy pendulum will swing back toward the right principles even after periods of distressing reversal.
“over time, many of the ideas in that book became, instead of being viewed as crazy or kooky or bizarre, became mainstream; and many of them were adopted.”
- The stagflation of the late 1970s—simultaneous high inflation and high unemployment in both the U.S. and Zimbabwe—was deemed impossible by versions of Keynesianism that posited a stable negative relationship between inflation and unemployment, and it became a major challenge to the Keynesian model; Friedman's 1968 AEA address had already explained why higher inflation cannot sustainably reduce unemployment.
“both Zimbabwe, and the United States at the end of the 1970s, managed to have both high inflation and high unemployment. And this became a big challenge in the academic literature, to the Keynesian model.”
- Permanent, predictable interventions are superior to temporary, short-run ones of unknown duration because people plan over more than tomorrow; certainty about the rules of the game makes people more likely to act, whereas uncertainty discourages action.
“The future matters a lot and if you know what the rules of the game are and you think that they are going to be the same for a while, you are more likely to act than if you are uncertain about what the rules of the game are going to be.”
- Reagan, like Friedman, spent a long time in a political wilderness and came to the presidency late after years of upholding and articulating his principles, which made it both harder for him to walk away from those principles and less appealing to give in to short-run pressures.
“it may have been beneficial that Reagan, like Milton Friedman, had spent a lot of time in the wilderness... I think it was both harder for him to walk away from those principles and less appealing to give in to the short run.”
Fed transparency and accountability have been systematically reduced under the guise of operational convenience.
- The Fed released its transcripts from the key 2008 meetings—a roughly 5,208-page document—but virtually all policy discussion was redacted, leaving only pleasantries, frustrating public understanding of the justifications for crisis-era policies.
“the Fed has finally released its transcripts from the 2008 key meetings... virtually all policy discussion has been, as they say, redacted. Which is a fancy word for blacked out”
- Removing the Fed's requirement to describe its policy because that was difficult and made it hard to be accountable is on one level reasonable but on another shocking—solving the difficulty problem by eliminating accountability rather than improving the way strategy is described.
“it's really hard for me to set my policy and then to be accountable. So, let's not have to describe what I'm doing. That does make it easier. It does solve the difficulty problem. It's strange.”
Electoral outcomes and partisan ideology matter less than the fiscal constraints any administration inherits.
- Despite being interventionist in many ways, the Carter administration under Alfred Kahn sowed the seeds of deregulation that continued under Reagan, illustrating that each administration mixed good and bad policies depending on one's philosophy.
“it also did, under Alfred Kahn, sow the seeds of deregulation, which continued under Reagan. But it started under Carter.”
- Whoever wins the next election, Democrat or Republican, will face the same fiscal and economic constraints regardless of their professed philosophy, so the identity of the winner may matter less than commonly assumed.
“I'm not sure how important it is who wins the next election. It will matter, but it seems to me that whoever wins, Democrat or Republican, will face some of these constraints regardless of their professed philosophy.”