Image credit: Claire Scully

When it comes to tracking U.S. inflation trends in 2024, Stanford economist John Taylor will be paying attention to policy not just domestically but internationally as well. There are many global aspects to the health of the economy, said Taylor in an interview with Stanford Report.

Here, Taylor talks about what lessons can be learned from the decisions the Federal Reserve Bank – or the “Fed” – made in 2023 to increase interest rates and the potential risks if it lowers them too soon in 2024.

Taylor is the Mary and Robert Raymond Professor in Economics in the School of Humanities and Sciences and the George P. Shultz Senior Fellow in Economics at the Hoover Institution.

In 1993, Taylor developed the influential “Taylor Rule,” which determines how a central bank should set interest rates in response to the rate of inflation and economic growth.

This interview has been edited for length and clarity.

With inflation coming down, what are some important lessons to be learned?

The lesson is pretty clear: Now that the Fed has raised rates, inflation is starting to come down again. The main issue was the Fed fell behind the curve in 2021 and 2022. We don’t know exactly why; it could have been the financial crisis and the hit to the economy that distracted them. Inflation got to be 9% or so, and most likely inflation would have continued to rise if they had kept rates so low.

Another lesson is monetary policy operates globally. We’ve seen some high inflation mistakes elsewhere, in Latin America and Europe, for example. What I hope is that the lesson here becomes a global lesson. We’re not out of the woods yet – that’s for sure. But I think that the Fed is a very important player in the monetary policy game. Other countries are looking to make sure that the Fed doesn’t make a mistake and let inflation rise.

The Fed has indicated that potentially three cuts could come this year. When will it be appropriate for them to be dialing it back? And what will Fed Chair Jerome Powell be looking for and making those decisions?

It’s a question that’s on a lot of people’s minds right now. I tend to think that the Fed should not go too fast. They should take it easy. They have these rules in place they publish, including the Taylor Rule. They’re very close to bringing inflation down to 2%. Seeing more substantial movement of inflation would be the reason to lower rates. There’s enough already to move it a little bit, but I wouldn’t say it’s going to be 3 points – it depends on what happens to the inflation rate. And if the inflation rate comes down faster than people currently expect, if it’s 2%, next quarter, then maybe that is enough to lower rates at an appropriate speed.

The risk is that it will not continue to go down and they will lower rates too fast. On the other hand, if they don’t do very much, you have a risk that we go back to where we were before. And I think that’s not what anybody wants.

Are there any other economic trends that you’re going to be paying attention to this year?

Regulatory and fiscal policy are very much part of the equation of what needs to be done. I think it’s key that the Fed encourages a more reasonable budget policy. With budget policy, you get into regulatory things. There’s so much dispute and disagreement about this. But if you look at the more successful periods in U.S. history and at other countries as well, having a little less regulation will be better.

The economic recovery we are seeing right now is being described as “a soft landing.” Is that a description or an assessment you would agree with?

“Soft” means we don’t have a recession but there is slower economic growth for a while. I don’t think we need to have either. I think we can move into relatively fast growth if the Fed and fiscal authorities go in the right direction. I hope we don’t have to have any landing at all. We had good growth in the last part of last year and we want that to continue.

A lot of people are hurting in this country and around the world, and the more we can do to stimulate growth and not have big recessions like we’ve had in the past can help. I’m very much of the view that a steady monetary policy is part of the factors that must be taken into account.

Taylor is also a senior fellow at Stanford Institute for Economic Policy Research.