Niklas Blanchard was an early supporter of market monetarist ideas, but then stepped away from blogging. I’m happy to report that he’s back with an excellent post. Niklas criticizes Taylor’s claim that interest rate targeting is like a price control. Of course it isn’t. I have to believe it was just a slip by Taylor, as he surely must know how the Fed targets interest rates via adjustments in the supply of reserves.
This makes very little sense given the fact that the Fed is shifting demand for assets. By buying assets now, and promising to buy them in the future, the Fed is directly influencing the demand for the assets that it buys. Taylor is claiming that the Fed is providing a cap on returns on holding assets. Taylor’s analogy says that this policy is like the government mandating that everyone get a flu shot (would would cause shortages of flu shots), when the proper analogy would be that the government is providing inoculations in order to keep the price low.
Perversely, it is the lack of forward guidance that Taylor seems to be seeking that necessitated the moves in the Fed’s balance sheet that Taylor is now worried about. Had the Fed been providing forward guidance the whole time (for instance, a target for the level of NGDP), it is more likely that NGDP would have remained stable throughout this entire period, and that the Fed’s balance sheet would be a fraction of the size it is today, and presumably we would not be having this conversation.