In the years before the crisis and recession, easy money and related regulatory policies should have shown up in demand pressures, rising inflation, and boom-like conditions. But the economy failed to overheat and there was significant slack.Taylor of late has been saying that our current mess was created by a deviation from the Taylor rule. Here’s his evidence:
Inflation was not steady or falling during the easy money period from 2003-2005. It was rising. During the years from 2003 to 2005, when Fed’s interest rate was too low, the inflation rate for the GDP price index doubled from 1.7% to 3.4% per year. On top of that there was an extraordinary inflation and boom in the housing market as demand for homes skyrocketed and home price inflation took off, exacerbated by the low interest rate and regulatory policy. Finally, the unemployment rate got as low as 4.4% well below the natural rate, not a sign of slack.Wow – hyperinflation! No one during the Bush Administration – its advisors (which included Taylor) nor its critics – were saying back then that the employment to population ratio had become dangerously high. The 4.4% unemployment rate – which corresponds to a 63.4% employment to population ratio – was not reached until late 2006. By then, we had seen two years of rising short-term interest rates. Now had Taylor and his fellow Bush economic advisors were very concerned about excessive aggregate demand – why did we not seen calls for fiscal restraint back then? If Taylor thinks this is a serious rebuttal to what Summers said, it is no surprise he has yet to acknowledge that 2010 forecast of inflation from QE.