I used this version: 2+p+(0.5(p-2)+y where p is year-over-year percent change in the PCE inflation index and y is the output gap: 2*(nairu-unemp) where 2 is the Okun coefficient and the nairu is from CBO.John Taylor had a couple of issues with what Jared wrote. I did too but my take is a little different than John’s. Let’s start with this:
He then goes on to give this definition the Taylor Rule: The federal funds rate should equal ... 2 + p + 0.5(p – 2) + y ... where p is year-over-year percent change in the PCE inflation index and y is the output gap: 2*(nairu-unemp) where 2 is the Okun coefficient and the nairu is from CBO ... But this is not the policy rule I recommended in a 1993 paper using a formula which has come to be called the Taylor Rule.Actually, Jared omitted a closing parenthesis so it is not clear if he meant the original Taylor rule or what John Taylor thinks Jared used. To be fair, the original 1993 formula should be simplified to: 1 + 1.5(p) + 0.5(y). Let’s make the algebra as simple as possible. John does admit:
I realize that there are differences of opinion about what is the best rule to guide policy and that some at the Fed (including Janet Yellen) now prefer a rule with a higher coefficient.But then he adds something where I would differ:
There are other important cross-checks on such calculations. Bernstein’s estimate of the output gap uses an Okun’s law coefficient of 2, but if you use 1.5 (the empirical estimate over the past 50 years) rather than 2, the gap is smaller, which also moves the rate up toward positive territory. Similarly, the average of the San Francisco Fed’s most recent survey of output gaps is smaller than what Bernstein uses.The original Okun’s law coefficient was actually 3, which would imply a 6.6% gap. I realize there have been other estimates such as an estimate where the coefficient was closer to 2.5 (implying a 5.5% gap). And if one uses the CBO’s measure of the output gap, which is mentioned in the SF Fed’s survey, it indicates an output gap equal to 5.8%. Even if the coefficient for the output gap is 0.5 – as in Taylor’s 1993 paper – an output gap of 5.8% and an inflation rate of 1% implies negative interest rates. But I guess John Taylor’s latest excuse for criticizing any expansionary stance from the FED is his belief that we are not that far from full employment. Go figure!