Also found in: Wikipedia.
Taylor rulea 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.