1. Will the real Taylor Rule please stand up?
Talk with Macro students
Miami University
Michael Bryan,
Vice President and Senior Economist

2. Language Establishing the Dual Mandate
Federal Reserve Act:
Language Establishing the Dual Mandate
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

3. THE FED FUNDS RATE: THE RATE AT WHICH BANK LEND RESERVES TO EACH OTHER OVERNIGHT. THE FOMC CONTROLS RESERVES, THEREFORE THEY CONTROL THIS RATE.
Percent, annual rate

5. i ff = (r* +  ) + α (y-y*) + β ( -*)
THE TAYLOR RULE: Is there a simple rule that tells a central bank like the Federal Reserve where to set the fed funds rate?
(Fed funds rate)
i ff = (r* +  ) + α (y-y*) + β ( -*)
Fisher equation
(defines long-run equilibrium)
The dual mandate:
1. GDP gap
2. Deviation of inflation from price stability
What values do you assign α and β?
Updated
Taylor 1993: α = 0.5 and β = 0.5

6. FOR THE MOST PART, THE FOMC (AT LEAST UP UNTIL 2003) SEEMS TO HAVE FOLLOWED THE RULE DESCRIBED BY TAYLOR.
Federal Funds Rate (%)
Taylor 1993
Actual fed funds rate

7. AND WHEN WE DIDN’T? Is the Fed getting behind the curve?
Federal Funds Rate (%)
Is the Fed getting behind the curve?
Taylor 1993
Actual fed funds rate
Did this “excess monetary stimulus” create a housing bubble and fuel the financial crisis?

8. YOU PLAY POLICYMAKER. WHERE WOULD YOU SET THE FED FUNDS RATE
YOU PLAY POLICYMAKER. WHERE WOULD YOU SET THE FED FUNDS RATE? HERE’S A START: THE CBO GAP ESTIMATE (BUT DON’T GET TOO ATTACHED TO YOUR ESTIMATE—THIS ISN’T A VERY EASILY MEASURED OBJECT).
1.7 = ( ) (-5.4) (0.1)
Next Update: data available December 2011
Source: CBO

9. which, with a little algebra and assuming an r* of 2 yields
Some have criticized Taylors 1993 rule as being overly weighted to inflation and not weighted enough to underperformance in the economy.
i ff = (r* +  )+ 0.5 (y-y*) ( -*)
which, with a little algebra and assuming an r* of 2 yields
i ff = (y-y*) 
After the original Taylor rules, other rules were introduced, some putting even more weight on inflation, some more weight on the economy. In a 1999 paper, this version of the Taylor rule emerged that weighted the economy more heavily.
Updated
i ff = (y-y*) 

10. Here is a comparison of Taylor’s 1993 rule and the so-called Taylor 1999 rule.
Federal Funds Rate (%)
Taylor 1993
Actual fed funds rate
Taylor 1999

11. According to the Taylor 1999 rule, the FOMC should push the fed funds rate deeply negative, which, of course is impossible. For all practical purposes the fed funds rate can not go below zero. This is called a “zero nominal bound” on interest rates.
Federal Funds Rate (%)
Taylor 1993
Actual fed funds rate
Taylor 1999

12. So how is monetary policy conducted at the zero nominal bound
So how is monetary policy conducted at the zero nominal bound? How does the FOMC conduct a policy that has the same impact as a negative fed funds rate? Quantitative easing—we expand our balance sheet so as to “mimic” a negative fed funds rate.
Start of QE1
Start of QE2

13. (Puts equal weight on slack and inflation) (Puts more weight on slack)
Still other Taylor rules have been proposed and a discussed in FOMC deliberations. Some of these rules allow for “inertial” fed funds rate adjustments, others use forecast values rather than current values for inflation and output.
Taylor 1993
(Puts equal weight on slack and inflation)
Taylor 1999
(Puts more weight on slack)

14. How long will the FOMC be faced with a zero nominal bound
How long will the FOMC be faced with a zero nominal bound? When will interest rates begin to rise again?
Percent, annual rate
2014?

15. Different rules, different forward guidance
Different rules, different forward guidance. Not everyone on the FOMC necessarily uses a Taylor-rule in deciding their preferred path for monetary policy. And those that do, use it with varying degree of faithfulness.
“In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions…are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”
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16. Will the real Taylor Rule please stand up?
Talk with Macro students
Miami University
Michael Bryan,
Vice President and Senior Economist