After Greenspan: The Taylor Rule?

You can't get in line fast enough to complain about Alan Greenspan these days. Want to bash his up-down decisions on interest rates on the op-ed pages of the Wall Street Journal or the New York Times? Take a number, and wait behind the bankers and professors. Eager to trash his endorsement of tax cuts? Expect to get his answering machine. He's on the other line talking to his old friend Robert Rubin, who put through an emergency call to Greenspan two weeks ago to try to muzzle the Fed chief's pro-slice stance.

In a way, it's a sensible snapback from the Greenspan worship we had before. Was it really right for one 72-year-old man, fond of long baths and Ayn Rand, to have so much control over our economy? "What would you do if something happened to Greenspan?" a reporter drilled John McCain during the primaries. "Well," said the Senator, "I'd put sunglasses on him and prop him up like that guy in Weekend at Bernie's." By last week, it was clear many folks were finally ready to bury Bernie. And that is going too far.

It's been a decade since Greenspan last faced such a long line of complainers. In 1991, as the post-Gulf War economy began cooling off like the Kuwaiti oil fields, conservatives begged Greenspan for a rate cut to help George Bush hold on to the presidency. Greenspan wouldn't play. His decision infuriated Republicans. But it also got a group of conservative economists noodling the idea of emasculating the Fed, removing much of the discretion that makes the institution both powerful and dangerous.

The leading advocate of this approach was a Stanford economics whiz named John Taylor, whom George W. Bush appointed to Treasury this month. In 1993 Taylor wrote a revolutionary paper that looked at how central banks in big countries had handled interest-rate policy in the period since the end of World War II. What Taylor discovered is that the best policy is based on a really simple premise--moving interest rates in the same direction as inflation, and doing so quickly. Say prices have shot up 3%. The best Fed policy, his study showed, was to respond by jacking interest rates. Higher rates mean it's more expensive to borrow, and that slows the economy down, tamping inflation. The idea works in reverse too: cutting rates helps pep up laagging growth. Under Taylor rules, anyone, even Bernie, could make monetary policy. In our globalized economy, the thinking went, everyone from China to Chile could have a Greenspan. All they needed was access to the right ratio and a laptop computer to crunch the numbers. A Greenspan box!

How much influence will Taylor have in Washington? Some say he may be to Bush what supply-sider Arthur Laffer was to Reagan. One key meeting to watch is the weekly get-together between Greenspan and Treasury chief Paul O'Neill. If Taylor starts showing up more regularly than, say, Deputy Secretary nominee Kenneth Dam, it may be a sign that the Administration is sending Greenspan a message. Or just a hint of Taylor's own ambitions. "There's no question," said one ex-Clinton official last week, "that this guy is talked about as a future Fed Chairman himself."

A Fed Chairman applying Taylor rules would be harder to bash, since he'd just be following the formula. But that would also limit the good he could do. Taylor rules, many economists say, don't work because they are reactive. They don't move rates until inflation picks up. It's like not hitting your brakes until you touch the other guy's bumper. Greenspan's rate cut in August 1998 probably saved the world from financial meltdown. Taylor's rules would have precluded the move. It's seductive to think we could build a Greenspan box, a computer to out-Alan Alan. But monetary policy can't be made in a vacuum. And as much as Taylor's acolytes might hope, it can't be made in a box either.

Can a box run an economy? Well, it couldn't run a hedge fund. Check out Roger Lowenstein's When Genius Failed, the story of Long Term Capital Management, the hedge fund that imploded in 1998. The book is Amazon.com's best seller among financial-services firms.