St. Louis Fed President James Bullard shares an alternative view


Oct. 30 2019, Updated 11:47 a.m. ET

Bullard’s alternative view

Bullard went on to talk about the international economy from an alternate view. Under this view, most features characterizing the economy remain the same as under the traditional view—except one. The only difference in the alternate view is that in this view, monetary policymakers in one or more countries don’t follow the good policy. This means the monetary policy doesn’t obey the Taylor principle in at least one country. That is, at least one of the national policymakers doesn’t adjust the degree of policy accommodation more than one-for-one in response to deviations of inflation from the target—assuming GDP growth versus the target remains constant.


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Bullard provided his audience the rationale for assuming some countries might not obey the Taylor principle. He said, “These are not normal times for monetary policy in the U.S. economy.” This stems from the fact that it’s difficult for policy to respond to declines in inflation when the policy rate is subject to the zero lower bound, which is the case in the U.S. currently. Moreover, quantitative easing (or QE) and forward guidance on policy estimates may or may not substitute effectively.

Changes in interest rates affect investor behavior to a great extent. Certain exchange-traded funds (or ETFs) like the ProShares Investment Grade-Interest Rate Hedged ETF (IGHG), which has its major holdings in companies like Citigroup Inc. (C) and JP Morgan Chase & Co. (JPM), the Vanguard Short Term Corporate Debt ETF (VCSH), and the PowerShares Senior Loan Fund (BKLN) are designed to protect investors against the interest rate risk caused by inflation.

Volatile equilibria

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So, if monetary policymakers in one or more countries don’t follow the good policy, the result would no longer take the shape of a unique worldwide equilibrium among economies. There would instead be multiple equilibria, all consistent with market clearing and rational expectations. This kind of volatility in equilibria would be much larger if key central banks were following more normal policies away from the zero lower bound.

The verdict

Under the alternate view, where some countries don’t follow the Taylor principle, the result would potentially be a lot of extra volatility in the global economy.

Now, whether the U.S. is following the Taylor principle or not hinges on what you think about unconventional monetary policy. Considering that the U.S. Fed funds rate is zero lower bound, if unconventional monetary policy is ineffective, then the global equilibrium may be overly volatile—as with the emerging market turmoil we’ve witnessed since former Fed Chairman Ben Bernanke hinted at the taper in his testimony to congress in May 2013.


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