Something funny transpired over the the past two years in the Fed's interpretation of the critical Taylor rule, which Bernanke refers to in every testimony before Congress or the Senate: John Taylor, the creator of the rule, and Zero Hedge's nomination for Fed chairman (inasmuch as we need a Federal Reserve) said Bernanke is wrong in his interpretation of the rule, and if he had a proper interpretation the Fed Chairman should already be hiking rate. Yet leave it to Bernanke to believe he knows better what the rule is supposed to mean....than even its creator. From the WSJ: "Stanford University professor John Taylor, an outspoken critic of the Federal Reserve in recent years, has a new complaint: He says Fed Chairman Ben Bernanke is misrepresenting Mr. Taylor’s eponymous rule on interest rates." A brief reminder on the Taylor rule, which has been presented numerous times on Zero Hedge before: "The Taylor Rule offers a simple formula that economists often use as a
guide for the appropriate level of the federal funds rate. The formula
provides changes in interest rates depending on the level of inflation
and the output gap, which is the difference between actual gross
domestic product and the economy’s potential output. Depending on how
you define the rule (for instance if you give the output gap a lot of
weight in the formula or just a little, or if you use a projected
inflation rate or actual inflation) you can come up with different
interpretations of whether interest rates should be high, low or even
negative in a theoretical world." And an odd dilemma appears when one uses the original version of the Taylor rule as presented in 1993 or its 1999 revision: they **provide totally different results**: the first one says the Fed is wrong, the second one validates QE. Yet here is Taylor himself: "**I did not propose or prefer an alternative rule in that 1999 paper, and it is hard to see how one could interpret the paper that way.**" **So is the entire US monetary policy based on a rule derivative that is not even endorsed by its creator?** The answer is a resounding **yes**.

From the WSJ:

Mr. Bernanke said Tuesday that the Taylor Rule suggested that short-term interest rates, if they could be, should be pushed way below zero. That, in turn, helped to justify the Fed’s $600 billion bond-buying program, he said.

When Sen. Pat Toomey, Republican from Pennsylvania, challenged him on whether Mr. Taylor himself believed that, Mr. Bernanke asserted even Mr. Taylor has come up with variations of his own rule. The one he originally formulated in 1993 doesn’t support the Fed’s current policy, but Taylor’s revision to it in 1999 does support the Fed’s current policy, Mr. Bernanke said.

“There’s no particular reason to pick the one that he picked in 1993. In fact, he preferred a different one in 1999 which, if you use that one, gives you a much different answer,” Mr. Bernanke said in an exchange Tuesday with Sen. Toomey.

Taylor’s 1999 paper (read it here) does point to alternate versions of his rule. But Mr. Taylor says he never stood behind any alternatives to his original 1993 rule. Instead he says he was citing alternatives that others proposed, including the Fed.The 1993 version of the rule calls for a federal funds rate of around 1%, not close to zero as it is now. He charges Mr. Bernanke with misrepresenting his preferences.

“I did not propose or prefer an alternative rule in that 1999 paper, and it is hard to see how one could interpret the paper that way,” Mr. Taylor says in a blog post today.

WSJ's Hilsenrath explains why this is such a material issue:

If this were just two academics feuding over a formula, it wouldn’t be very interesting. But it’s more than that. Mr. Bernanke is the Fed chairman. Mr. Taylor is one of the most influential voices in monetary economics and he’s saying the Fed chairman is distorting his views to justify a controversial policy.

“It is important to correct the record because the ‘others have suggested’ rule has a much larger coefficient on the GDP gap and is therefore more likely to generate negative interest rates and be used to rationalize discretionary actions such as quantitative easing,” he says on his blog.

And below is the full transcript of the exchange between Bernanke and Toomey:

MR. BERNANKE: I think that many of the monetary or nominal indicators that somebody like Milton Friedman would look at did suggest the need for a monetary stimulus. For example, nominal GDP has grown very slowly. Growth in the money supply is in fact — I’m not talking about the reserves held by banks which are basically idle — but if you look at M1 and M2, those have grown pretty slowly. The Taylor Rule suggests that we should be, in some sense, way below zero in our interest rate, and therefore we need some method other than just normal interest rate changes to —

SEN. TOOMEY: Do you know if Mr. Taylor believes that?

MR. BERNANKE: Well, there are different versions of the Taylor Rule, and there’s no particular reason to pick the one that he picked in 1993. In fact, he preferred a different one in 1999 which, if you use that one, gives you a much different answer.SEN. TOOMEY: My understanding is that his view of his own rule is that it would call for a higher Fed funds rate than what we have now.

MR. BERNANKE: There are, again, many ways of looking at that rule, and I think that ones that look at history, ones that are justified by modeling analysis, many of them suggest that we should be well below zero. And I just would disagree that that’s the only way to look at it.But anyway, so I think there are some — there is some basis for doing that.

Which begs the question: is the broken US monetary system so institutionalized that the only person willing to speak up against the faulty usage and interpretation of a rule, is its own creator? What would happen should the Fed follow the Taylor-endorsed rule is that QE2 would immediately have to be ended. But of course this will never happen: after all it is now clear the Fed's policy was never to actually control inflation or maximize unemployment: the whole point was always just to get stocks as high as possible. And when the bubble pops, which it will, it will be time to point fingers, and we are confident that the Fed will resort to blaming Taylor himself. Luckily by then there will be no Fed, as the monetary system will have finally reverted back to its one sustainable form, backed by either precious metals or some other non-dilutable instrument.

The fiat experiment has taken enough casualties.

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