The Taylor Rule  Explained
What is Taylor's Rule?
 Marketing, Advertising, Sales & PR
 Accounting, Taxation, and Reporting
 Professionalism & Career Development

Law, Transactions, & Risk Management
Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes  Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
 Business Management & Operations
 Economics, Finance, & Analytics
 Courses
What is the Taylor Rule?
Taylor's rule is a mathematical formula intended to serve as a guideline for the U.S. Federal Reserve and other central banks for adjusting interest rates in the shortterm in response to changes in economic conditions such as inflation and the unemployment rate. This rule is named after John B. Taylor, an economist at Stanford University, who introduced it in 1993 with the goal of adjusting and setting judicious interest rates that not only helped in stabilizing the economy in the shortterm, but also fostered longterm growth. According to Taylors rule, there are three determinants of real shortterm interest rates (i.e. interest rate adjusted for inflation)
 The targeted level of inflation in relation to the actual inflation levels.
 The actual levels of employment in relation to full employment.
 An interest rate that is appropriately consistent with full employment in the short term.
Back to:ECONOMIC ANALYSIS & MONETARY POLICY
How does the Taylor Rule Work?
Taylors rule is extensively used to forecast future interest rates with different values of economic variables such as population, poverty rate and inflation as input. Results obtained by the application of this rule are intended to serve as guidelines for the Federal Reserve to make changes to its interest rates according to prevalent parameters such as inflation and the employment rate. The rules of thumb in the application of Taylors rule are as follows:
 Interest rates should be raised during periods of high inflation or in instances where employment surpasses full employment levels.
 Conversely, interest rates should be lowered during periods of low inflation and /or low employment levels.
A Brief Timeline of Taylor's Rule
1993: Taylors Rule was invented and published by John Brian Taylor (1946  ), an economist and academician at Stanford University. The same year, fellow economists, Dale W. Henderson of Georgetown University and Warwick McKibbin of the Australian National University proposed the same rule. 1999: John Taylor adapted and updated Taylors Rule. 2003: Athanasios Orphanides, a prominent economist from Cyprus, publicized his reservations against incorporating Taylors Rule in policy making since, according to him, the rule would not hold up to realtime data (RTD). 2015: Ben Shalom Bernanke, who had served two terms as Chair of the Federal Reserve, endorsed Taylors Rule in an article published in April, 2015. The same year, William Hunt Gross, an American investor, advocated a total abandonment of Taylors Rule, citing that low interest rates were not the solution for decreased growth. 2017: The Financial CHOICE Act of 2017 mandated a rigid version of Taylors Rule known as Directive Policy Rule (DPR) for the Fed to follow. The proposed DPR was met with strong opposition by economists, including John Taylor himself, who was averse to the use of his rule as a mechanical formula. Taylor, instead, advocated a much more informal implementation and operation of Taylors Rule by policymakers.
Taylors Rule as an Equation
John Taylor's original version of the rule can be represented mathematically as follows: it = t + r*t + (t  *t) + y(yt  t) where, it is the target shortterm nominal interest rate, t is the inflation rate according to the GDP deflator, *t is the desired rate of inflation, r*t is the assumed equilibrium real rate of interest, yt is the logarithm of real GDP, and t is the potential output logarithm, as determined by a linear trend. Also, according to Taylor's original paper, both and y should have positive values with the proposal that = y= 0.5. In 2015, Ben Shalom Bernanke proposed a simplified formula of Taylors Rule as follows. r = p + 0.5y + 0.5(p 2) + 2, where, r is the federal funds rate of interest, p is the inflation rate, and y is the percent deviation of real GDP from the desired GDP. From the above equations, it is possible to draw a simple inference from Taylors Rule, which is that inflation is merely the difference between the real interest rate and thenominal interest rate. While real interest rates do factor in inflation, nominal interest rates do not. Although the primary purpose of Taylors Rule is to scrutinize potential targets for interest rates, the same is not possible without considering the allimportant economic variable of inflation. However, it is vital to form a comprehensive understanding of the economy visvis prices in order to draw an accurate comparison between inflation and noninflation rates. Widespread disagreements still persist among experts regarding the veracity of Taylors Rule while some prominent economists, including policymakers have publicly endorsed John Taylors original proposition or a modified version of the same, others have opposed any form of implementation of the rule. Detractors have vehemently cited shortcomings such as inaccuracies while using realtime data as well as the alleged inability of the rule to adjust to sudden or drastic changes in the economy. Nevertheless, it is beyond doubt that Taylors Rule has by far, vastly improved the practice of central banking as a whole, despite the irony that the Federal Reserve the institution for which it was created in the first place does not explicitly follow it.
Related Topics
 Legal Tender
 Numismatics
 Gresham's Law
 Barter
 Double Coincidence of Wants
 Parity
 Functions of Money
 Medium of Exchange
 Unit of Account
 Store of Value
 Time Value of Money
 Standard of Deferred Payment
 Liquidity Preference Theory
 National Savings and Investment Identity
 Circular Flow of Money
 Commodity Money
 Gold Exchange Standard
 Bretton Woods System
 Fiat Money
 Money Supply
 M1 and M2 Money Supply
 Monetary Base
 Savings, Demand, and Time Deposits
 Banks
 How Do Banks Create Money?
 Financial Intermediary
 Bank Balance Sheet
 Money Multiplier Formula
 Velocity of Money
 Multiplier Effect
 Quantity Equation of Money
 McCallum Rule
 Neutrality of Money
 Real Bills Theory
 Banking System?
 Central Bank
 Federal Reserve System
 Federal Open Market Committee (FOMC)
 Fed Balance Sheet
 Term Auction Facility
 Taylor Rule
 How is the Federal Reserve Bank Organized?
 What is Bank Regulation?
 CAMELS Rating
 FDIC
 CFPB
 Bank Supervision
 Bank Runs
 What is Deposit Insurance?
 Federal Deposit Insurance Corporation
 Lender of Last Resort
 Central Banks Carry Out Monetary Policy
 Open Market Operations
 Bank Reserve
 Discount Rate
 Federal Funds Rate
 Monetary Policy
 Contractionary and Expansionary Monetary Policy
 Loose vs Tight Monetary Policy
 Easy Monetary Policy
 Accommodative Monetary Policy
 Dove & Hawk (Monetary Policy)  Explained
 Tight Monetary Policy  Explained
 Stabilization Policy
 Pushing on a String
 The Effect of Monetary Policy on Interest Rates
 Federal Funds Rate
 Gibson Paradox
 Vasicek Interest Rate Model
 Equation of Exchange (Economics)
 The Effect of Monetary Policy on Aggregate Demand
 Quantitative Easing
 Reserve Currency
 What are Excess Reserves?
 Unpredictable Movements of Velocity
 Central Banks  Unemployment and Inflation
 Inflation Targeting
 Fisher Effect
 Asset Bubbles and Leverage Cycles
 Countercyclical
 Money Capital Market
 Quantity Theory of Money
 Aggregate Expenditure Model
 ISLM Model
 European Capital Market Institute