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John Taylor Rule Formula and Calculator
Taylor Rule Equation and Calculator
The Taylor Rule, which is a simple formula that John Taylor devised to guide policymakers. It calculates what the federal funds rate should be, as a function of the output gap and current inflation. Here, we measure the output gap as the difference between potential output (published by the Congressional Budget Office) and real GDP. Inflation is measured by changes in the CPI, and we use a target inflation rate of 2%. We also assume a steady-state real interest rate of 2%. These are a lot of assumptions, and you are welcome to change them on the calculator by playing around with the formula to see how the Taylor Rule matches up with the effective federal funds rate.
r = p + 0.5y + 0.5(p-2) +2
r = nominal fed funds rate
p = the rate of inflation
y = percent deviation between current real GDP from the target GDP
The Taylor rule is used as forcasting model to determine what the interest rates should be to shift the economy towards to normalized fed funds rate.
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