Taylor rule


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Taylor rule

Describes how a central bank should adjust short-term interest rates (e.g. the Federal Funds rate) in response to inflation or output gaps. According to the rule, the interest rate should be increased if inflation rises above the target rate of inflation or if real GDP rises above trend GDP (increasing interest rates would squeeze credit supply to decrease demand and bring prices under control.) On the other hand, if inflation or real GDP fall below their target values, interest rates should be decreased. Proposed by economist John B. Taylor in 1993.

Taylors Rule

A general rule for central banks when deciding interest rates. The rule states that interest rates should be increased in times of high inflation and when employment is higher than full employment, and should be decreased in periods of low inflations and higher unemployment. The rule states that following these principles will encourage growth while discouraging inflation. The Federal Reserve follows this rule implicitly, even though it does not explicitly endorse it.

Taylor rule

a specific policy rule for fixing US INTEREST RATES proposed by the American economist John Taylor. Taylor argued that when real GROSS DOMESTIC PRODUCT (GDP) equals POTENTIAL GROSS DOMESTIC PRODUCT and INFLATION equals its target rate of 2%, then the Federal Fund Rate should be 4% (that is, a 2% real interest rate). If real GDP rises 1% above potential

GDP, then the Federal Fund Rate should be raised by 0.5%. If inflation rises 1% above its target rate of 2%, then the Federal Fund Rate should be raised 0.5%. This rule has been suggested as one that could be adopted by other central banks, such as the EUROPEAN CENTRAL BANK and the MONETARY POLICY COMMITTEE of the Bank of England, for setting official interest rates.

However, the rule does embody an arbitrary 2% inflation target rather than, say, 3% or 4%, and it may need to be amended to embody alternative inflation targets at different times or by different central banks. The advantages of having such an explicit interest rate rule is that its very transparency can create better conditions for business decisions and can help to shape business people's and consumers’ expectations.

References in periodicals archive ?
Monetary policymakers often use simple policy rules, like the Taylor rule, as an input into their decision-making.
The Taylor rule (proposed by the Stanford University economist John Taylor in the early 1990s) is often used to describe central banks' interest-rate policies.
In effect, the actual Bundesbank-ECB rate moved closely in tandem with the interest rate predicted by a Taylor rule applied to Germany.
Let me begin by noting that the Taylor rule is heavily used in analysis at the Federal Reserve and plays an important role in thinking about how monetary policy should respond to changing economic circumstances.
These changes also lead to similar movements in the inflation rate when the monetary policy follows the standard Taylor rule, failing to recognize the time-varying nature of the natural rate of interest.
The analysis is based on a variant of the Taylor rule framework.
While Oxford Economics has a neutral outlook for Philippine monetary policy in 2016, lead Asia economist Priyanka Kishore said in a recent report that an analysis of real interest rates and the Taylor Rule suggest that a more expansionary monetary policy could be justified in Japan, Thailand, Philippines, Singapore and India.
The most popular description of contemporary monetary policy is the Taylor rule (see Taylor 1993).
The Taylor rule is a simple equation that economists and others in the public use to anticipate the future path of the federal funds rate.
The Taylor Rule is an equation that prescribes the central bank's interest rate based on the amount that inflation and unemployment are deviating from their targets.
Linear Taylor rule prescribes symmetric response to inflation rate and output gap in good and bad times.
To illustrate their operation and explore their limits, this article examines three principled norms: (1) the real bills doctrine, which played a critical role shaping Fed policy from its 1913 founding through 1935; (2) the Taylor Rule, a formula proposed by Stanford economist John Taylor for setting interest rates in a way that balances the Fed's dual aims of promoting full employment and maintaining stable prices; and (3) Bagehot's dictum, a set of guidelines proposed by Walter Bagehot in the nineteenth century regarding how a lender of last resort should respond to liquidity shortages.