economics terms

Taylor Rule

John Taylor proposed the following rule designed to guide monetary policy:

i = r* + pi + 0.5 ( pi - pi*) + 0.5 ( y - y*)

where i is the nominal federal funds rate, r* is the "natural" real federal funds rate (often taken to be 2%), pi is the rate of inflation, pi* is the target inflation rate (for example, 2%), y is the logarithm of real output, and y* is the logarithm of potential output.

The two basic ideas here are to raise the federal funds rate to one-half the extent that inflation exceeds its target and to lower the federal funds rate to one-half of the percentage that real output falls below its potential.  Implicit in this formulation is that a reasonable rule of thumb applied consistently over time is more likely to achieve a good outcome than is aggressive manipulation of monetary policy.  It is widely believed that central banks have paid close attention to variations on this Taylor Rule in recent years.

See also:  Federal Funds Rate and Discretion versus policy rules in practice, John B. Taylor, Carnegie-Rochester Conference Series on Public Policy 39 (1993), 195-214.

Classic Economic Models
   Interactive presentations of the most important models
   in microeconomics and macroeconomics go beyond
   anything appearing in a printed-on-paper textbook.
   Learn to think like an economist. 


Classic Economic Models

Economics Terms

Arbitrage Pricing
Arbitrage Profit
Average Cost
Balance of Payments
Budget Constraint
Call Option
Concave Function
Consumer Surplus
Consumption Function
Convex Function
Deadweight Loss
Demand Curve
Economic Agent
Economic Model
Economics Textbook
Endogenous Technical Change
Exchange Rate
Expectations Hypothesis
Federal Funds (Fed Funds) Rate
Fixed Exchange Rate
Floating Exchange Rate
Frictional Unemployment
Gross Domestic Product (GDP)
Income Effect
Income Elasticity
Indifference Curve
Interest Rate
Intertemporal Substitution
Jensen's Inequality
Marginal Cost
Marginal Product
Marginal Utility
Optimizing Behavior
Perfect Competition
Phillips Curve
Price Elasticity
Producer Surplus
Production Function
Production Possibility Frontier
Put Option
Reservation Wage Rate
Risk Aversion
Structural Unemployment
Substitution Effect
Supply Curve
Taylor Rule
Technological Growth
Term Structure
Theory of the Consumer
Theory of the Firm
Unemployment Rate
Utility Function
Velocity of Money
Yield Curve