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Headline: Taylor-made policy Source: Euromoney Date: September 2001 There are few bigger jobs in finance than US Treasury undersecretary for international affairs. So meet John Taylor, the former academic economist who finance ministers and central bank governors from around the world will be courting for the next few years. Taking time out from the negotiations over Argentina he delivers some tough messages on official sector financing packages: they should come with fewer conditions, but those conditions should be strictly monitored and enforced, before funds are disbursed. He offers to share useful experience with Japan, expresses confidence in the European single currency project and explains to James H Smalhout why the US current account deficit is sustainable
A prominent macroeconomist from Stanford University in California, the man has been a fixture in Republican policy-making circles since working for president Gerald Ford’s Council of Economic Advisors in 1976. His research, including the well-known Taylor Rule, has gained a wide following for its ability to describe, predict and guide monetary policy. Taylor, who taught economics at Columbia, Princeton and Yale before joining the Stanford faculty in 1984, displays a decidedly conservative, even cautious demeanour. He is organized and disciplined enough to produce a highly successful series of textbooks while carrying a normal teaching load and continuing to work on his influential research. But there’s another side to the man that made him immensely popular with his 18 and 19-year-old students. “We, at Stanford, have always had the rule that Econ One is taught by some of our most distinguished faculty members,” says John Shoven, a former dean and Taylor’s long-time colleague in the economics department there. “But John stood out as the best even in that group. People would go out of their way to take his course.” Taylor typically attracted 700 students – almost half of Stanford’s entering class – each time that he offered the Economics One course. And he would go to extraordinary lengths to breathe life into the dismal science. When he wants to, Taylor can cut a colourful figure, once having morphed himself into a California raisin during a lecture from the stage of Stanford’s Kresge auditorium. Now, Taylor can morph himself again – this time on the world stage. Will he appear next as Scrooge or as Mr Deep Pockets? Taylor found time between meetings with Argentina’s creditors to speak with Euromoney in late August. Concerning the Argentine crisis, how do you evaluate the risks associated with the recent IMF proposal to extend another $8 billion in credit to that country? There are a number of things that could occur in the economy that we need to worry about. I think that the main focus should be on reducing risks. There are two important benefits from this package. One is that $5 billion of it would be used to bolster the banking system, where there has been a decline in deposits. That will give people more confidence that the banking system is sound and so there won’t be a reason to withdraw deposits from banks. That reduces risk. The other component is $3 billion to help facilitate debt exchanges or debt operations. That also should reduce risk because it gives a greater degree of sustainability to the Argentine economy. In the event that this level of support turns out not to be adequate to bring about an end to the crisis, what is plan B? The IMF recommendation does not simply say: ‘This is it, the end.’ It says: ‘Here are some funds to address the deposit outflow. In addition, here are some other funds which can be used to promote continued discussion of ways to address sustainability.’ So, it is not like all the programmes before this, where the question came up about what happens next. This is supposed to be a continuing discussion for finding a constructive framework. So, in that sense, it’s meant to be different and I believe that it is different. There is also another part of this that I really want to stress. The US, at the same time that the IMF announced its recommendation, called for a meeting of the Mercosur four, plus the US, to discuss trade – not only the WTO effort to have a new trade round, not only the FTAA, but also the bilateral possibilities. So, there’s definitely an attempt here to think about this programme in terms of trade as an engine of growth. That’s an important part of it. You have been holding meetings here today with Argentina’s private creditors. Do you believe that the time has come for them to accept losses on their investments in that country? What level of burden sharing should private investors assume in this situation? One thing that you notice about markets – if you participate in them or talk to people who participate in them – is that there’s a huge number of different views involved and a huge number of different positions. Some people in the markets are long and some are short. Some are underweight. Some are overweight. So, it’s actually not possible to assess the impact of policy choices without looking at all the different perspectives and views and positions. We have tried to be clear about the need to find a way to have fewer crises, about the need to stay on top of events more and about the need for people to make the tough decisions when they are necessary. The programmes of the IMF should have less conditionality and countries should take that conditionality seriously. More of the conditions in IMF programmes should be prior conditions, so there’s not a question about their being implemented. Conditions should be fulfilled before disbursements take place. The resources of the official sector are limited. That was a point that we made very strongly in the IMF programme with Turkey. There was a lot of discussion about bilateral assistance, but we restricted it to the IMF. Also, that programme had a lot of prior actions. There is, in the case of Argentina, an attempt not just to throw money at a problem, but also to have a way to use it constructively to address potential problems down the road. In this way, incentives for the government and the IMF are better. Developing countries want to have a good amount of private capital flows. The resources of the official sector can’t grow as rapidly as you want this asset class to grow. Official support is limited and we can’t have these big elephant packages anymore. So, we have to find a way to make private capital flows grow. Burden sharing and private sector involvement mean so many different things to different people. There are people who already have taken big losses on emerging market debt. There are people who have made good gains. Some people are out of the market. So I think what we need to do in the public sector is to be as clear as possible about what our intentions are, so that the private sector can make calculated assessments of the risks and there’s no misleading anybody about what actually is going to occur. Secretary O’Neill has signaled that he wants to shift the emphasis, at the IMF as well as here at the Treasury, from crisis management to crisis prevention. What new strategies do you think offer the greatest potential for preventing crises in the future? I think that the greater use of flexible exchange rates has improved the way in which markets adjust. That’s a big change. That can be combined with some target for inflation, even if the target is not numerically stated. I would think of that approach as a policy rule, a way for the central bank to set policies with flexible exchange rates. On the other extreme, you have a single currency, dollarization or a credible currency board. It is in between these two extremes that we run into trouble, as we did with pegged regimes in the Asian crisis and in Russia. I believe in this bipolar view. Close monitoring is also very important. But it’s more than just monitoring – it’s making tough decisions. IMF programmes can be enforced more effectively if their conditionality is more focused. That prevents crises, too, by making matters clearer to people. I also think that providing more information – not just from the private sector, but also from the public sector – enables investors to discriminate better from one country to another and therefore prevents contagion. It doesn’t eliminate contagion, but it reduces it. That’s another big aspect of crisis prevention, and we’ve seen some improvements in this over time. What changes in the so-called international financial architecture would you favour to promote greater economic stability around the world? I hesitate to use the word ‘architecture’. I think it gives policymakers a sense they’re building something from scratch, when in fact there is already a context – namely, very important markets made up of private individuals, buying and selling, that improve people’s well-being. I think the simple phrase ‘international financial system”’is just fine. We need to continue to work to have countries follow policies that are, number one, good for their own economy. That gets you 95% of the way to a well-functioning international monetary system. That means keeping inflation low as well as having fiscal policy that is steady and responsive at the same time, but avoids a lot of government intervention, especially in areas where there’s no rationale for it. Of course, this doesn’t deal with every problem. The G7 process, for example, can make things work more smoothly by promoting a cooperative exchange of information about what’s going on in one country or another and also by exchanging views. Policies that involve the IMF, the World Bank and the Bank for International Settlements are all also very important. These institutions can help promote the adoption and implementation of standards that help realize the other 5% of what’s needed for a well-functioning international financial system. The US, for example, has a good set of standards for its commercial banking system. But not all countries have those standards. There is therefore a need to cooperate on these kinds of supervisory questions. The issue of governance at the IMF has been debated over the years and over-representation of the European countries has been a bone of contention. Do you plan to take steps to resolve this controversy? It’s important to have these discussions about how institutions should change. I find that so many things are set up because they made sense when the institutions were started. If you now started from scratch, you’d probably do it differently. But I think we have to be very cautious about changing things radically in a way that would upset how things are working. So, I think that we should focus on changes that will make them more effective, like increasing the use of grants or improving crisis prevention. Secretary O’Neill complained recently that the world has too little to show, in terms of poverty reduction, for the resources that have been made available to the World Bank and the regional development banks. What specific reforms of these institutions, particularly at the World Bank, do you believe hold the most promise for improving their effectiveness? Number one is to set priorities in a way that is very clear, so that they’re not doing too many things and being too diffuse. Secretary O’Neill has used those specific terms. He is focused on productivity growth, which is the number one way that countries can grow and people can earn more. We know this from experience with the whole economy, with sectors of the economy, and with individual firms. When you look at a map of the world and identify the countries that are rich and poor, the rich countries are the ones with high productivity and the poor ones have low productivity. So, development strategies that focus on raising productivity growth create a good set of priorities. Every programme, every grant, every loan and every project should be considered in terms of how it raises productivity. I think that would go a long way towards improving the effectiveness of the MDBs. One of the most significant reforms that is on the table now is the one that president Bush announced in his speech at the World Bank just before he went to the G8 summit in Genoa. The president’s proposal would take half of the loans that are now being made to the poorest countries and use them to fund grants. In this way, you can deal with a lot of the bad incentives that are created by calls for debt forgiveness. If it’s really a grant, call it a grant. Dedicate the grants to education and health care and other projects that boost productivity, and tie them to results like enrollment, test scores or delivering a certain number of vaccines. I think that it’s important for middle-income countries to begin to graduate from World Bank support so that more resources can be focused on the poorest countries, largely in Africa. There should also be a greater degree of coordination between the various multilateral development banks. It’s been my experience with these multilateral development banks that there is a lot of overlap. It is also very important to me that people ask more tough questions ahead of time about what they’re doing and about the need to show results. If we all do that as shareholders of these institutions, the institutions themselves would work better. The previous administration had a notable lack of success in its efforts to persuade Japan to take the steps that could have enabled it to break out of economic stagnation. What are you planning to do about this problem? First, we would like to follow president Bush’s model here: to have an exchange with other countries as partners, to talk with them as equals and not to talk down to them or to try to dominate them. That’s something that we try to have in all of our exchanges. With Japan, in particular, I think that it’s appropriate. The second thing is to reflect on our own experience and expertise and to share that with them. With respect to the non-performing loan problem, for example, the US had a huge experience with our version of that in the late 1980s. It was resolved by the Resolution Trust Corporation and that worked well. It was a smaller problem in proportion to GDP, but it gave us some expertise. I have a lot of interest in monetary policy, so we could talk about the Bank of Japan’s policy. On fiscal policy we can discuss ways for the deficit to be reduced in a gradual way. So, those are the two things for the public sector. The new engagement with Japan also will have a private-sector element. I think having the business-to-business exchange running parallel to the government-to-government exchange is important. This is, in my experience, something that has quite a bit of potential. Business people have a lot of knowledge that they can share. That would occur naturally in a democracy, of course, where there’s a great deal of exchange of information. But we would like to encourage that to feed into the public sector so that the public sector gets more involved. This summer, for example, we took a trip to Russia after the Putin-Bush summit meetings. It was the economic component of the interaction with Russia. The two cabinet officials that went on that trip were secretary O’Neill and secretary [of commerce] Evans. Both had been very successful in business and they met with people trying to do business in Russia, including people like small entrepreneurs trying to take over old shipbuilding factories. They had a better dialogue with the Russian government officials afterward as a result. So, dialogue with the private sector is something that we want to stress in Russia and other countries as well. How do you assess the prospects for success of monetary integration in Europe? I think it will be successful. It already has been successful – just look at the experience of Italy in reducing inflation. I think the authorities have been able to resist pressures in Europe for inflating away problems. The central bank has done well in that respect. It’s true that there are some tensions caused by bringing separate central banks together into one. That requires a lot of coordination and you run into problems with some regions growing more rapidly when there is not as much labour mobility as in the US and taxes are somewhat higher. But I basically think that the prospects are good. I think that it’s going to work fine when they actually finish the introduction of euros into circulation in January of next year. Some people argue that the US current account deficit, at more than 4% of GDP, is not sustainable. What is your opinion? I don’t think it’s unsustainable. I think that there’s too much attention paid to the surpluses and deficits between countries, especially countries that have ready access to foreign capital and flexible exchange rates. The way to think about the current account deficit – or surplus, if you have a surplus – is the difference between investment and savings. Right now and for a number of years, the US has been a good place to invest and investment is high. Americans are choosing to save less than the amount that’s being invested. So, investment from abroad must flow in, and foreigners want to invest in the US because it’s a good place to invest. That creates not only the current account that we see, but it also creates the means to pay for that current account deficit because these investments generate rates of return, and are not simply consumed away. That’s what makes the system sustainable. For countries that are in surplus, of course, it’s the exact opposite. In Japan, for example, their saving is greater than their overall investment and they have a savings surplus. Would it be feasible to step away from the recent ever-increasing dollar and simply maintain a strong dollar? Or, is a weaker dollar policy the only realistic alternative? One thing that we’ve tried to make very clear in this administration is that there’s no change in the strong dollar policy and that the secretary of the Treasury is the spokesman on the dollar. I think that’s the best way for me to answer your question. What is the Taylor Rule and why did you see a need for it as a tool for describing monetary policy? Also, has the time come to use the Taylor Rule as a guide for policymaking, instead of merely a description? The idea was motivated by two things. First, because of my interest in monetary policy I kept being asked whether the Fed should increase, decrease or leave steady the Federal funds rate. Second, I have been a proponent of the idea that policy should be transparent and conducted in a systematic way since I started working in economics: the general idea of rules as guidelines for policy was something that had interested me since I had been in college. Those two things together told me that what I really needed to do was to find a rule that would determine whether the interest rate that the central bank was setting should be higher, lower or the same. That was basically the motivation. The rule is that the central bank should change the overnight interest rate if inflation picks up or if economic growth slows down. The amount by which the interest rate should change actually is quite specific. So, for example, if inflation picks up by one percentage point, the overnight interest rate should be increased by 1.5%. If real growth slows down by 1%, the overnight interest rate should be cut by 0.5%. Some of the germs of the idea came when I was working at the Council of Economic Advisors during the first Bush administration. One chapter in the 1990 economic report of the president included a discussion of the importance of having systematic policies as well as the importance of credibility. When I returned to Stanford in 1991, I thought about how this could be made more operational and looked at a lot of research that I had done and other people had done on policy rules. The basic idea that informed the method was that researchers like me would take models of the economy, sometimes very complex models, and stick in different policy rules to see which rule worked well. I had one model of the G7 countries that consisted of about 100 equations. Based on that I tried to find a rule that was pretty simple but produced desirable results. And it turned out to be remarkably simple. There’s always been some confusion among people about whether the rule was meant to be descriptive or normative, because it came to be used as a descriptive device over time. But I didn’t develop it to be a descriptive device. I meant it to be a guideline, or normative tool, because I was looking at the models to see which rule worked best. But it did describe behaviour reasonably well, especially for such a simple rule. The original idea in the paper that I wrote worked out scenarios showing how the Fed could have used it as a guide to policy. |
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