Taylor Rule
The Taylor rule is a simple policy reaction: set the policy rate to a neutral real rate plus inflation, then add weights on the inflation gap and the output gap.
Definition
i = r* + π + 0.5(π − π*) + 0.5 y, in the 1993 form. The Taylor principle is that the coefficient on inflation must exceed one so real rates rise when inflation rises. It is a benchmark, not a law the FOMC votes on.
Why it matters
Markets use the gap between the funds rate and a Taylor path as a stance gauge. ‘Behind the curve’ is often that gap in slang.
Case
2003–05: a Taylor rule using core PCE sat well above the actual funds rate — the ‘too low for too long’ critique. 2021–22: the same object said policy was late as inflation printed 6–9%.
How to read it
Name r*, the inflation index, and the output-gap vintage. Change those three and the ‘rule’ moves 100–200 bp. It is a language, not a thermostat.
Key papers
Landmark references with real publisher or arXiv links — not token-overlap noise.
- Discretion versus Policy Rules in PracticeTaylor · 1993 · Carnegie-RochesterThe original Taylor rule.