Fed needs to hike rates a bit more, Taylor rule creator says

The Federal Reserve needs to raise interest rates a bit further to rein in an inflation rate that’s too high, monetary expert John Taylor said.

“They’ve had a big adjustment over the last couple of years,” the Stanford University professor told a webinar hosted by the American Council for Capital Formation on Thursday, adding, “I think they should go a little bit higher.”

The Fed took a break from its credit-tightening campaign last month after increasing rates by five percentage points starting in March 2022. A preponderance of policymakers expect to raise rates by at least 50 basis points by the end of this year, according to projections released after their June 13-14 meeting.

Taylor, whose eponymous rule for guiding monetary policy is consulted by central banks around the world, faulted the Fed for not following its precepts as policymakers kept interest rates near zero while inflation took off and the pandemic waned. 

“It would be a healthier economy if we were back towards 2%” inflation, he said.

To further enhance the health of the economy, Taylor also advocated further reductions in the federal government’s budget deficit, less regulation and freer trade.

Just as monetary policy benefits from following simple rules like the one he developed, fiscal policy would be better off doing the same, he said.

“Why can’t we have a fiscal policy where we have a balanced budget in normal times?” he asked.

A sensible policy to reduce the budget deficit gradually would allow interest rates to be a bit lower and would reduce the risk that the Fed would be pushed into monetizing the government debt, Taylor said.