Related Resources: Engineering Manufacturing Economy

### Taylor Rule Equation and Calculator

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

FFRt = rtLR + πt + 0.5 ( πt - π* ) + 0.5 ( yt - ytP )

Where:

FFRt = Federal funds rate in quarter

rtLR = neutral federal funds rate in the longer run (adjusted for inflation)

πt = four quarter inflation rate

π* = central bank's objective for inflation

( yt - ytP ) = measures the oercentage difference of GDP from its potential rate

Eq. 2, Taylor's original version

it = rt* + πt + aπ ( πt - π* ) + ay ( yt - yave-t )

Where

it = target short-term nominal policy interest rate (e.g. the federal funds rate in the US

πt = the desired rate of inflation

rt* = the assumed natural/equilibrium interest rate

πt = desired rate of inflation

yt = the natural logarithm of actual GDP

yave-t = the natural logarithm of potential output

aπ = typically 0.5, should be a positive number > 0 this is the relative importance of inflation for monetary policy

ay = 1 - aπ

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:

Related