Taylor: Fed Partly to Blame for Global Inflation

John Taylor thinks the Fed needs to tighten policy to reduce the pressure on global inflation:

Easy policy behind global inflation: Taylor, Reuters: Inflation is rising globally because of an easy monetary policy, ... John Taylor said... To tackle rising inflation, Taylor urged the world's policy-makers to talk about adopting a global inflation target.

The creator of the so-called "Taylor rule" of monetary policy, which stipulates that interest rates should rise by more than the increase in inflation..., said U.S. interest rates are now below appropriate levels indicated by the rule.

"During the past year, as global inflation has risen, global short term interest rate targets set by central banks have not increased on average by as much as inflation," Taylor said in a conference on monetary policy hosted by the Bank of Japan.

The average targets have in fact declined since the credit market crisis started in the middle of last year, largely due to sharp rate cuts by the Federal Reserve, said Taylor, now an economics professor at Stanford University.

When interest rates are declining ... in the United States, other central banks have tended to be reluctant to raise rates because that could lead to a sharp appreciation of their own currency, he said.

"Because of concerns about exchange rates and the impact on the exports sector, on the economy in general, central banks are not following the principles that they come to think of as important," Taylor said.

That leads to higher commodity prices, driving inflation all around the globe, he said.

"There is strong evidence that at least part of the increase in energy and commodity prices is related to the global inflationary pressures and thereby, in part, to the policy response to the financial crisis in the United States," he said.

The global dimension of current inflation means a global response is necessary.

"A good place to start is with discussions about some kind of global inflation target," he said, adding that such a target does not need to be a strict numerical target.

I'd like to hear more about what he has in mind for the mechanics of global inflation targeting, i.e. how it would be coordinated across central banks. Credibility of the promises of other members of the coalition in such an arrangement would seem to be one difficult hurdle to overcome (though not the only one), so there would have to be strong penalties for deviating from the global inflation targeting rule. But that would discourage nations from joining in the first place unless they were convinced that the extra restrictions they'd have to follow as part of the coalition would bring them benefits (such as reducing exchange rate changes brought about by a trading partner pursuing a high inflation policy) they couldn't get on their own by strict adherence to a domestic inflation target. [One minor technical point. The article says that the "'Taylor rule' of monetary policy ... stipulates that interest rates should rise by more than the increase in inflation...," but this is usually called the Taylor principle, not the Taylor rule.]