Taylor’s rate is making a comeback
An old-school, oft dismissed guide for interest rates has spiked dramatically, suggesting the Fed needs to raise rates without mercy.
The Taylor rule is an equation John Taylor, a professor of economics at Stanford University, developed in 1993 that prescribes a value for the Federal funds rate based on the level of inflation and economic slack. Different versions of this rule using other measures for inflation and economic slack, such as the labour underutilisation rate or real GDP gap, have been created over the years since Taylor’s original paper.
However, in his commentary, Taylor endorsed calling the version of his rule from 1993 the ‘Taylor rule’ and referring specifically to that version for monetary policy. However, former Fed Chairs Ben Bernanke and Janet Yellen have both said they prefer alternative versions called ‘modified Taylor rules’ that focus on labour underutilisation over real GDP.
The Federal Reserve Bank of Atlanta reports quarterly on the Taylor rate, including three versions. I have created a sort-of Taylor rate index by taking the average of the FOMC preferred Taylor rate focused on labour unde…