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 ?
My starting point to characterizing the nature of monetary policy across countries is the standard Taylor rule (1993), which specifies a link among nominal interest rates, inflation, and the output gap.
The 'Taylor Rule,' named after the prominent economist John Brian Taylor of Stanford University and former US undersecretary of treasury for international affairs, is another guide to assessing the proper stance on monetary policy.
Monetary policymakers often use simple policy rules, like the Taylor rule, as an input into their decision-making.
The Taylor rule, under which the monetary authorities target the short-term policy rate so that it responds to divergences of actual inflation rates from target inflation rates, and to deviations of actual gross domestic product (GDP) from potential GDP, and Friedman's money-supply growth rule share several important attributes.
Section III.C discusses estimated impulse responses of key macroeconomic and financial variables to the structural shocks of the model and disentangles the stabilization properties of a credit-growth-augmented Taylor rule. Section III.D presents the analysis of the variance decomposition to assess the importance of the exogenous structural shocks.
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.
We find that monetary authority in Pakistan does not follow Taylor rule as coefficient of output gap is negative and statistically insignificant and the coefficient of inflation rate, though statistically significant, is far below the benchmark value suggested by Taylor (1993).
This legislation requires the Fed to frame monetary policy using a mathematical formula--something akin to a Taylor rule. 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.
For this purpose, we estimate several specifications of a Taylor rule for monetary policy in Poland and use the estimates for calculation of ex-post interest rate path simulations to compare the actual interest rate with the scenario of no change in the central bank's preferences.
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.