Taylor = bear steepener
Top Fed chair pick and the causes of slow growth
Trump said yesterday that he is “very, very close” to picking a new Fed chair, naming three possible candidates, including economist John Taylor.
Taylor’s August 2016 paper on the causes of slow growth shed some light on what his leadership on the Fed might mean. Here are the most important charts from the paper:
Adverse policies suppress capital services to an extent Taylor calls “unprecedented” (this is a BLS direct estimate not a residual). They also suppress labor force participation. Taylor thinks a combination of a 3% rise in the Labor Force Participation Rate and an increase in capital services could restore high labor force productivity growth.
But Taylor is also on record saying that a perverse effect of artificially low term yields is a disincentive to lenders to provide credit to businesses. See the WSJ op-ed below.
The implication is a bit different from what Joachim Fels (who was probably pushed onto PIMCO by its parent Allianz) is saying:
Taylor would be more aggressive in reducing the Fed’s portfolio (unless he has changed his mind since his 2013 op-ed) because he thinks higher term yields are POSITIVE for growth. He would be cautious about using the funds rate as a tool for fighting inflation because he believes that a positive supply-side shock might ensue from beneficial fiscal and regulatory policies. In other words, Taylor portends a bear steepener.
The idea that Bernanke and Yellen created perverse effects by keeping term yields low was a Shibboleth in the supply-side world for years. David Malpass (also one of the original supply-siders) wrote a number of WSJ op-eds making the same argument as Taylor.