Controlling Inflation: The Taylor Principle

[wabmester]

I just learned about the Taylor principle. I imagine we might be hearing more about this in the days ahead, as it is what guides the Fed in their fight against inflation. The fed recently signaled that inflation is at the high-end of their comfort zone, and that could mean aggressive tightening. How aggressive?

My understanding is that the Taylor principle says that the fed should increase the nominal rate by more than the difference between expected inflation and their inflation target.

So, for example if their target is around 3%, expected inflation looks like 5%, then they will increase interest rates by more than 2%.

The idea is to make interest rates so attractive to consumers that they save their money, postpone purchases, and thereby bring inflation back in check.

This will be interesting to watch. It might mean a relatively quick rise in rates to over 6%, depending on how much the fed thinks that might dampen economic output, whether the inflationary spike is short-term, and other factors.

Hold on to your hats! (Or consider taking evasive action.)

[dex]

Three things may temper that policy.
1. Raising intrest rates also slows down business growth, employment
2. Higher interest rates detrimential to those with variable mortage rates and other variable debt
3. Energy costs act as a defacto fed reserve hike or fed government tax precluding those increases.

I must say I like the idea. I have a lot of cash I'm waiting to invest. However, I currently do not have a fixed 30 year mortage - I don't have a house.

[bosco]

Quote:

Originally Posted by dex Three things may temper that policy. 1. Raising intrest rates also slows down business growth, employment 2. Higher interest rates detrimential to those with variable mortage rates and other variable debt 3. Energy costs act as a defacto fed reserve hike or fed government tax precluding those increases. I must say I like the idea. I have a lot of cash I'm waiting to invest. However, I currently do not have a fixed 30 year mortage - I don't have a house.

yes, rising rates cause some pain but inflation is totally devastating to those on fixed income (many pension plans, annuities etc.) I'm sure many of us can remember people in the 70s who thought they were done working, until inflation got into double digits for a few years and cut their legs out from under them.

I say...crank those rates up. Forget 1/4 point increases--let's go for 1/2!. Let's pop this #*$*) housing bubble and see what's on the other side of this lunacy. Besides, if Greenspan lets inflation get out of hand, it encourages irresponsible behavior by the government. If they are allowed to inflate away their debt too easily, they'll just go out and borrow more money to start another war. I say "starve the beast" (to throw Republican dogma back at them). Unfortunately, this beast just steals and borrows other animals' food when it gets hungry, which is also inflationary. Hmmm. Easy to blame Greenspan, but I think the problem resides more with our "elected" officials.

I wonder if Bush's nominee to replace Greenspan will be as qualified as his last nomination to the Supreme Court. Scary thought..... :

[Peter]

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Originally Posted by bosco I wonder if Bush's nominee to replace Greenspan will be as qualified as his last nomination to the Supreme Court. Scary thought..... :

I am 'reliably' informed that he is going to nominate the guy at H&R Block that does his personal taxes ...

Peter

[retire@40]

Quote:

Originally Posted by bosco I wonder if Bush's nominee to replace Greenspan will be as qualified as his last nomination to the Supreme Court.

It would be nice to see someone like former US Treasury Secretary Robert Rubin as a replacement.* From what I remember, he did a great job for the US Treasury, he is well respected on Wall Street, and both parties like him.

[wabmester]

I think the leading candidate is Ben Bernanke, you know that sweetheart of a guy who came out right after Katrina killed a bunch of people and said "I don't think this storm will have a big economic impact."

I was reading a few fed speeches last night, including a long one of Bernanke. All of these guys are pretty interesting. Bernanke has some wacky ideas about our current account deficit, and all of the fed guys are certain that they are in control of the economy (mostly based on the last 10-years or so of data). And they think you think so too, which is why they think the markets have become less volatile, inflation is tame, and all they need to use is a little rhetoric to keep things in line.

Digging a little deeper, though, it becomes clear that the rely on fairly simple models, and they're not really sure what do in response to an energy price shock.

Anyway, if they pull the trigger on the Taylor Principle, it means that for a while at least, we'll have high inflation coupled with high real interest rates and a slow economy. Not good for bonds (even TIPS), stocks, real estate, or probably anything else besides cash.

[yakers]

Cash, hey thats me. I have some bucks sitting in my credit union andI cannot figureout what best to do with it (younger son starting college in 1 1/2 years) and E Fund. So maybe will I end up appearing very smart financially to be sitting on this cash.

[haha]

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Originally Posted by wab I just learned about the Taylor principle.* *I imagine we might be hearing more about this in the days ahead, as it is what guides the Fed in their fight against inflation.* *The fed recently signaled that inflation is at the high-end of their comfort zone, and that could mean aggressive tightening.* *How aggressive? My understanding is that the Taylor principle says that the fed should increase the nominal rate by more than the difference between expected inflation and their inflation target.

Do you maybe have a link that might help put this in context with Federal Reserve thinking?

Ha

[wabmester]

Quote:

Originally Posted by HaHa Do you maybe have a link that might help put this in context with Federal Reserve thinking?

I recommend reading all of the fed speeches -- plenty of insight if you can filter out the posturing:

http://www.federalreserve.gov/boarddocs/speeches/2005/

But the one that had me chasing down inflation targets and the Taylor principle is this one.

As an aside, everybody should read Bernanke's spiel on the global saving glut for some potential insight into how and why foreign banks keep our economy afloat as well as his thoughts on which countries we should be investing in.

[Gone4Good]

Quote:

Originally Posted by dex Three things may temper that policy. 1. Raising intrest rates also slows down business growth, employment 2. Higher interest rates detrimential to those with variable mortage rates and other variable debt 3. Energy costs act as a defacto fed reserve hike or fed government tax precluding those increases.

But aren't those three things the whole point of raising rates - to wring excess demand out of the system? *

Quote:

I must say I like the idea. *I have a lot of cash I'm waiting to invest. *However, I currently do not have a fixed 30 year mortage - I don't have a house.

As a "net lender" I have to admit I'm not sorry to see the end of free money. *But I'm scared to death about what a pricking of the real estate bubble is going to do to the rest of my investments. *

[just_hatched]

Quote:

Originally Posted by wab I recommend reading all of the fed speeches -- plenty of insight if you can filter out the posturing: http://www.federalreserve.gov/boarddocs/speeches/2005/

Does "posturing" include all of the sentences that are written in Greek?

Anyone know the "Fed -> Simple English" translation site?

[REWahoo]

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Originally Posted by wab I recommend reading all of the fed speeches --

--- if you suffer from insomnia.

[TargaDave]

Quote:

Originally Posted by wab Anyway, if they pull the trigger on the Taylor Principle, it means that for a while at least, we'll have high inflation coupled with high real interest rates and a slow economy. Not good for bonds (even TIPS), stocks, real estate, or probably anything else besides cash.

Well, if you want to go one step further, even "dollars" are risky according to the serious bears out there. Whether the dollar has more to fall is anyones guess but the bears will tell you to diversify into foreign currencies as well as that ever so popular bear sweetheart, gold. At $474 that might take some guts. Even today gold is the investment everyone loves to hate.

[wabmester]

Quote:

Originally Posted by REWahoo! if you suffer from insomnia.

Some of these are really page turners. I couldn't put Bernanke down!

For insomnia, I recommend a primer on macroeconomics:

Mac 101

Quote:

Originally Posted by TargaDave even "dollars" are risky according to the serious bears out there.

According to Bernanke, our dollar is being propped up on at least a mid-term basis by many foreign central banks. No idea on how or when it'll unwind.

[cute fuzzy bunny]

Quote:

Originally Posted by wab Not good for bonds (even TIPS), stocks, real estate, or probably anything else besides cash.

Hmm, so yesterday TIPS are good for the upcoming financial scenario and cash is silly. Today TIPS might be bad, cash is good.

Might be nice to separate the wildly different opinions by at least a week or so...

[wabmester]

Quote:

Originally Posted by () Hmm, so yesterday TIPS are good for the upcoming financial scenario and cash is silly.* Today TIPS might be bad, cash is good. Might be nice to separate the wildly different opinions by at least a week or so...

That's the difference between you and me. When I see new compelling evidence, it can change my view. You, on the other hand.... Well, let's just say that I expect your tombstone to read "Admit it, wab, that Inspiron 1000 is much better than the Altair 8800 everybody was boasting about in 1975. Ha, I was right!" That's OK, though. You're a marketing guy. You can't help it.

Anyway, *IF* the fed aggressively raises rates such that real rates rise faster than inflation, then TIPS will take a hit, but they'll still perform better than other bonds in an inflationary environment. I don't know how aggressively the fed will act. I'm holding onto my TIPS.

[mikew]

It's almost the weekend and we're talking about inflation. I think I hear Greg's PC warming up.

[Gone4Good]

Quote:

Originally Posted by wab Anyway, *IF* the fed aggressively raises rates such that real rates rise faster than inflation, then TIPS will take a hit, but they'll still perform better than other bonds in an inflationary environment.* * I don't know how aggressively the fed will act.* *I'm holding onto my TIPS.

I Bonds! Put your low yielding ones right back to the feds and grab that higher real yield.

[cute fuzzy bunny]

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Originally Posted by wab That's the difference between you and me. When I see new compelling evidence, it can change my view.

At least my view isnt usually wrong...

[wabmester]

Quote:

Originally Posted by () At least my view isnt usually wrong...

OK, let's bury the hachet. I'll stop talking about your extra-large butt if you stop making up bogosities and defending them to the death.

Besides, sticks and stones can break my bones, but your comebacks are WEEEEEAK!