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### Taylor Rule Equation and Calculator

Engineering Manufacturing Economics Data

The Taylor Rule Equation and Calculator

The Taylor Rule, which is a simple formula that John Taylor devised to guide Federal monetary policymakers. It calculates what the federal funds interest rate should be, as a function of the output gap and current inflation.

Eq. 1 Used by The Federal Reserve

*FFR _{t} = r_{t}^{LR} + π_{t} + 0.5 ( π_{t} - π^{*} ) + 0.5 ( y_{t} - y_{t}^{P} ) *

Where:

*FFR _{t} =* Federal funds rate in quarter

*r _{t}^{LR}* = neutral federal funds rate in the longer run (adjusted for inflation)

*π _{t}* = four quarter inflation rate

*π ^{*}* = central bank's objective for inflation

* ( y _{t} - y_{t}^{P} ) * = measures the oercentage difference of GDP from its potential rate

Eq. 2, Taylor's original version

*i _{t} = r_{t}^{*} + π_{t} + a_{π} ( π_{t} - π^{*} ) + a_{y} ( y_{t} - y_{ave-t} ) *

Where

*i _{t} =* target short-term nominal policy interest rate (e.g. the federal funds rate in the US

*π _{t} *= the desired rate of inflation

*r _{t}^{*}* =
the assumed natural/equilibrium interest rate

* π _{t}* =
desired rate of inflation

*y _{t}* = the natural logarithm of actual GDP

* y _{ave-t} = *the natural logarithm of potential output

*a _{π} =* typically 0.5, should be a positive number > 0 this is the relative importance of inflation for monetary policy

*a _{y} =* 1 -

*a*

_{π}In the United States, the Federal Open Market Committee controls monetary policy. The committee attempts to achieve an average inflation rate of 2% (with an equal likelihood of higher or lower inflation). The main advantage of a general targeting rule is that a central bank gains the discretion to apply multiple means to achieve the set target.

Source:

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