Central banks not only broke the rules leading to the financial crash, but again in response to tackling the crisis. A return to a situation where governments, together with surrounding institutions, follow rules rather than use their own discretion should be an explicit policy goal.

Whilst rules go so far, nominal GDP targeting – whereby the level of nominal spending is greater than the rate of growth – could allow central banks such as the Bank of England to react earlier, and choke off artificial booms and destructive busts. Constrained discretion may also correct for overconfidence in the ability of institutions to constrain themselves.

This new publication from the Institute of Economic Affairs brings together the differing views of three prominent economists – John Taylor, Patrick Minford and the Bank of England’s Andrew Haldane – to outline lessons from the great recession, with three perspectives on government and institutional approaches to monetary policy.

1. A return to Taylor Rule

• The breakdown of rules-based monetary policy in favour of discretion has been hugely damaging. John B. Taylor, one of the foremost economists in our generation outlines how the huge gap between actual interest rates and the level suggested by the Taylor rule* between 2003-5 was at least partly responsible for the crash and following slow recovery. He makes the case that other areas of policy became erratic, such fiscal stimulus packages with changes in taxes and special subsidies offered to particular types of economic activity.


• Side-effects included an increase in arbitrary regulation. In the US, between 2006 and 2012 the number of workers engaged in regulatory activity grew from around 180,000 to nearly 240,000. In the 1980s the reverse happened.


• Governments failed to learn lessons from the past leading up to the financial crash. In the 20 years before the run-up to the crash, an adherence to stable, rules-based policy combined with good economic performance. The introduction of discretion in the early-2000s led to the reverse.


• The rise of discretionary monetary and fiscal policy can make it difficult for governments commit credibly to low inflation. It also runs the risk of political considerations trumping sound monetary policy, as electorates can suspect that central banks will follow instructions to loosen monetary policy to engineer short-term rises in output and employment, especially with an election around the corner.

2. Adopt nominal GDP targeting

• Leading economist Patrick Minford suggests that Taylor’s rule to keep inflation under control might not have been enough to avert the financial crisis. Inflation-targeting is misguided; it may stay close to target even after a prolonged period of loose monetary policy – by which point the central bank will take too little action too late.


• Targeting nominal national income would lead to greater monetary tightening more quickly as expansion develops, making it less likely financial instability will follow. We should still follow rules, but the targets should be different.

3. Constrained discretion

• Following rules must go hand-in-hand with judgment. The Bank of England’s’ Andrew Haldane and Amar Radia argue that even the Taylor rule requires a judgment about the size of the output gap and equilibrium level of interest rates at which monetary policy is neutral.


• Constrained discretion creates a set framework within which decisions should be made, while also allowing judgments to be made for individual policies. Committee stratures, such as the Bank of England’s MPC, prevent biases affecting policy unduly. This would correct for over-confidence in the ability of institutions to constrain themselves.

Commenting on the report, Professor Philip Booth, Academic and Research Director at the Institute of Economic Affairs, said: 

“Since the crash, central banks and regulators around the world have adopted erratic policies that have undermined recovery. They have increased regulation on the financial sector and imposed regulations on the banking sector that actively work against monetary policy objectives. We need to return to a stable monetary policy regime which will enable the economy to thrive whilst not creating financial bubbles.”

Notes to Editors:

For media enquiries please contact Stephanie Lis, Director of Communications: slis@iea.org.uk or 020 7799 8900 or 07766 221 268.

To download the full report, Policy Stability and Economic Growth: Lessons from the Great Recession, click here.

The Taylor Rule is how much a central bank should change the nominal interest rate in response to a change in inflation or other macro-economic variable. Adherence to such a rule can reduce uncertainty, improving an economy’s performance.

John B. Taylor is the Robert Raymond Professor of Economics at Stanford University and the George P. Shultz Senior Fellow in Economics at the Hoover Institution. John Taylor’s academic fields of expertise are macroeconomics, monetary economics and international economics. In particular, he is known for his research on the foundations of modern monetary theory and policy. He has served on the US President’s Council of Economic Advisors, the US Congressional Budget Office’s panel of Economic Advisors and the California Governor’s Council of Economic Advi­sors. From 2001 to 2005, John Taylor was Under Secretary of the US Treasury for International Affairs, where he was responsible for, amongst other things, currency markets, trade in financial services and oversight of the Interna­tional Monetary Fund and the World Bank.

Andrew Haldane is the Chief Economist at the Bank of England and Executive Director, Monetary Analysis and Statistics. He is a member of the Bank’s Monetary Policy Committee. He also has responsibility for research and statistics across the Bank. In 2014, Time magazine named him one of the 100 most influential people in the world. Andrew has written extensively on domestic and international monetary and financial policy issues. He is co-founder of ‘Pro Bono Economics’, a charity which brokers economists into charitable projects.

Patrick Minford is Professor of Applied Economics at Cardiff University, where he directs the Julian Hodge Institute of Applied Macroeconomics. Between 1967 and 1976 he held a variety of economic positions, including spells in East Africa, in industry and at HM Treasury. From 1976 to 1997 he was the Edward Gonner Professor of Applied Economics at Liverpool University. He was a Member of the Monopolies and Mergers Commission from 1990 to 1996, and one of the HM Treasury’s Panel of Forecasters (the ‘Six Wise Men’) from 1993 to 1996. He was made a CBE in 1996.

Amar Radia is a manager in the Financial Stability Strategy and Risk Directorate at the Bank of England. He was previously an economist in the Bank’s Monetary Analysis Directorate.

The mission of the Institute of Economic Affairs is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems.

The IEA is a registered educational charity and independent of all political parties.