Editing Taylor rule (section)

{{short description|Rule from monetary policy}}
{{Distinguish|Taylor Law|Taylor's law|Taylor's theorem}}
The '''Taylor rule''' is a [[monetary policy]] targeting rule. The rule was proposed in 1992 by American economist [[John B. Taylor]]<ref>{{Cite web|title=Interview with John B. Taylor {{!}} Federal Reserve Bank of Minneapolis|url=https://www.minneapolisfed.org:443/article/2006/interview-with-john-b-taylor|date=March 8, 2006|editor-last=Clement|editor-first=Douglas|website=www.minneapolisfed.org|language=en|access-date=2020-05-22}}</ref> for [[central bank]]s to use to stabilize economic activity by appropriately setting short-term [[interest rate]]s.<ref>{{Citation |last1=Judd |first1=John P. |title=Has the Fed Gotten Tougher on Inflation? |date=2020-04-30 |url=http://dx.doi.org/10.4324/9780429270949-48 |work=Handbook of Monetary Policy |pages=635–639 |publisher=Routledge |access-date=2022-11-24 |last2=Trehan |first2=Bharat|doi=10.4324/9780429270949-48 |isbn=9780429270949 |s2cid=154075608 }}</ref> The rule considers the [[federal funds rate]], the [[price level]] and changes in [[real income]].<ref name="John B. Taylor 1993">John B. Taylor, Discretion versus policy rules in practice (1993), Stanford University, y, Stanford, CA 94905</ref> The Taylor rule computes the optimal [[federal funds rate]] based on the gap between the desired (targeted) [[inflation rate]] and the actual inflation rate; and the [[output gap]] between the actual and natural output level. According to Taylor, monetary policy is stabilizing when the [[nominal interest rate]] is higher/lower than the increase/decrease in [[inflation]].<ref name="ReferenceA">{{Cite report |last=Mishkin |first=Frederic |date=February 2011 |title=Monetary Policy Strategy: Lessons from the Crisis |doi=10.3386/w16755 |website=National Bureau of Economic Research|doi-access=free }}</ref> Thus the Taylor rule prescribes a relatively high interest rate when actual inflation is higher than the inflation target.

In the [[United States]], the [[Federal Open Market Committee]] controls monetary policy. The committee attempts to achieve an average inflation rate of 2% (with an equal likelihood of higher or lower inflation). The main advantage of a general targeting rule is that a central bank gains the discretion to apply multiple means to achieve the set target.<ref name="Lars E. O 2003">{{Cite report |last=Svensson |first=Lars E. O.|date=January 2003 |title=What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules |doi=10.3386/w9421 |website=National Bureau of Economic Research|doi-access=free }}</ref>

The monetary policy of the [[Federal Reserve]] changed throughout the 20th century. Taylor and others evaluate the period between the 1960s and the 1970s as a period of poor monetary policy; the later years are typically characterized as [[stagflation]]. The inflation rate was high and increasing, while interest rates were kept low.<ref>{{Cite web |title=Causes of the Financial Crisis and the Slow Recovery: A 10-Year Perspective {{!}} Stanford Institute for Economic Policy Research (SIEPR) |url=https://siepr.stanford.edu/publications/working-paper/causes-financial-crisis-and-slow-recovery-10-year-perspective |access-date=2022-11-24 |website=siepr.stanford.edu |language=en|last=Taylor|first= John B. |date=January 2014|publisher=Hoover Institution Economics Working Paper}}</ref> Since the mid-1970s monetary targets have been used in many countries as a means to target inflation.<ref name="Pier Francesco Asso 2010">{{Cite journal |last1=Asso |first1=Pier Francesco |last2=Kahn |first2=George A. |last3=Leeson |first3=Robert |date=2010 |title=The Taylor Rule and the Practice of Central Banking |journal=SSRN Electronic Journal |doi=10.2139/ssrn.1553978 |issn=1556-5068|publisher=The Federal Reserve Bank of Kansas City|s2cid=153150134 }}</ref> However, in the 2000s the actual interest rate in [[Developed country|advanced economies]], notably in the US, was kept below the value suggested by the Taylor rule.<ref name="Boris Hofmann 2012">{{Cite book |first=Boris |last=Hofmann |title=Taylor Rules and Monetary Policy A Global 'Great Deviation'? |oclc=1310400578|year= 2012}}</ref> 

The [[Taylor rule]] represents a rules-based approach to monetary policy, standing in contrast to discretionary policy where central bankers make decisions based on their judgment and interpretation of economic conditions. While the rule provides a systematic framework that can enhance policy predictability and transparency, critics argue that its simplified formula—focusing primarily on inflation and output—may not adequately capture important factors such as financial stability, exchange rates, or structural changes in the economy. This debate between rules and discretion remains central to discussions of monetary policy implementation.