Wednesday, February 11, 2009

John Taylor: Giving Banks Money Hurts Banks

John Taylor undoubtedly made some great contributions to monetary economics—foremost among them being the famous Taylor Rule. But an astute observer of financial markets he is most certainly not. His diagnosis of the financial crisis is comical at best. It really is unhinged from reality. Taylor really jumps the shark when he claims that the government's handling of the bailout, rather than Lehman's collapse, caused the financial crisis:

The realization by the public that the government's intervention plan had not been fully thought through, and the official story that the economy was tanking, likely led to the panic seen in the next few weeks.
This is literally nonsensical. If Lehman's collapse actually hadn't harmed the financial system, then uncertainty about which financial institutions the government was planning to shower with money wouldn't have caused investors and counterparties to flee because, after all, the financial institutions were fine, and why would investors and counterparties flee financial institutions that were perfectly healthy? Think about it. Why would a plan to give money to banks—even a poorly thought-out plan—cause counterparties to flee banks and other financial institutions? If the financial system really didn't need bailing out, as Taylor seems to believe, then the government money was just icing on the cake. This is yet another example of why you shouldn't rely on academic economists to explain the financial crisis.


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