'Solvency rule' versus 'Taylor rule': an alternative interpretation of the relation between monetary policy and the economic crisis

Abstract

One of the more debated interpretations of the economic crisis that started in 2007–08 is based on the ‘Taylor rule’ equation, namely the idea that over the period 2002–05 the Fed has implemented a low-interest policy that has led to the housing bubble and finally to the ‘Great Recession’. This paper shows that the Taylor rule equation not only rests on the so-called ‘new consensus macroeconomics’, but also on the neoclassical theory of growth. The various criticisms raised against these theoretical foundations suggest that interpretations of the Great Recession based on the Taylor rule equation are building their arguments on shaky theoretical premises. Furthermore, this paper shows that an equation formally similar but logically alternative to the Taylor rule can be regarded as the expression of a general condition of solvency of firms and workers. According to this ‘solvency rule’ the prevailing outcome of monetary policy decisions is the ‘regulation’ of insolvencies.

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