The Taylor rule (TR) is a monetary-policy rule developed by John Taylor (1993). It states that the central bank must modulate the short-term interest rate (e.g. Federal Fund rate) in response to discrepancy between the actual inflation rates and the target inflation rates, and between the actual and potential output. The TR can be written as follows:
- it is the policy instrument and is the interest rate consistent with full employment;
- is the actual rate of inflation and is the inflation target;
- is the actual aggregate output and is the potential output;
According to the TR, when inflation is above its target or when the production is above its potential level, the central bank should rise the interest rate. On the contrary, when inflation is below its target or when the output is below potential output level, a so-called “easy” monetary policy is recommended.
Taylor J.B. (1993), "Discretion Versus Policy Rules in Practice", Carnegie-Rochester Conference Series on Public Policy, Vol. 39, pp. 195-214.
Editor: Lorenzo CARBONARI
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