OPINION: With inflation already running hot, the Fed is playing with fire, economist John Taylor argues.
STANFORD, Calif. —Over the past few months, there has been a growing chorus of economic observers voicing concerns about the increase of inflation in the United States.
Moreover, the Taylor rule implies that even if the inflation rate falls to 2% by the end of this year , and economic output reaches its potential, the federal-funds rate still should be 3%. That is a long way from the near-zero level implied by the Fed’s forward guidance. The problem with this line of reasoning is that the low longer-term rates are likely being caused by the Fed’s own insistence on keeping low rates as far as the eye can see. As Josephine M. Smith and I show in a 2009 study, there is a “Term Structure of Policy Rules” to consider. Effectively, the policy rule for longer-maturity bonds depends on the policy rule for the much shorter-term federal-funds rate FF00, +0.00%, as perceived by people in the market.
Today, it appears that the Fed is deviating from monetary-policy rules. It has beaten its own path for forward guidance, and the market is basing its estimates of future rates on the expectation that this deviation will continue.
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