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 ?
The Taylor Rule is an equation that prescribes the central bank interest rate based on the amount that inflation and unemployment are deviating from their targets.
Given that the dual mandate of the Federal Reserve includes inflation and employment, many people write the Taylor rule in terms of an employment gap instead of an output gap.
So the Taylor rule separately targets a nominal variable and a real variable.
Coates argues that the capacity of anyone to conduct qualified CBA with any real precision or confidence does not exist for important financial regulations like a Taylor rule.
The Taylor rule is an equation which is used to describe the factors that have helped shape past monetary policy decisions.
On the other hand, evidence also suggests that changes in political regimes are able to account for the deviations from the optimal Taylor rule (JEL E52, E58, D78)
Perhaps for this reason, Fed Chair Yellen also has discussed (in an April 2012 speech) the forward guidance that would be forthcoming were a central bank to set policy according to a version of a Taylor rule.
We initially assume that the Central Bank base rate only responds to inflation and output, employing a standard Taylor Rule.
The Taylor rule and the transformation of monetary policy.
Both the output growth and price-level path rules generate less volatility in output and inflation following a persistent productivity shock compared with the Taylor rule.
The article proceeds as follows: Section 2 outlines the model, section 3 presents the specification of our disaster shock and its effects on the capital stock and output, section 4 examines the effect of a disaster when the Federal Reserve follows a standard Taylor rule, section 5 analyzes the optimal monetary policy response to a disaster, and section 6 concludes.
If oil prices rise and a Taylor Rule is in place, then inflation will be above target for a sustained period, and will eventually come back to target.