Taylor Rule

Understanding Taylor Rule

Proposed by economist John Taylor in 1993, the rule raises the policy rate when inflation is above target or output is above potential, and lowers it in the opposite case.

Central banks do not follow it mechanically, but it is widely used as a benchmark for judging whether policy is tight or loose.

Formula

Here, $r^{*}$ is the neutral real rate, $\pi$ inflation, $\pi^{*}$ the inflation target, and $y - y^{*}$ the output gap in percent.