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The so-called Taylor rule, named after its
author Stanford University professor John Taylor, delivers an
estimate for the appropriate level of interest rates based on
the rate of inflation and the level of economic slack.
Recently, however, the equation has generated contradictory
policy guidance, spitting out a negative interest rate when
economic slack is measured in terms of economic growth, but a
positive interest rate when slack is measured in terms of
unemployment, the paper argued.
"Determining whether the economy is overheating or
underperforming is critical for monetary policy," Early Elias,
Helen Irvin and Oscar Jorda, the authors of the paper, wrote.
"Our analysis highlights the difficulties of using the Taylor
rule as a practical guide to implementing monetary policy in
real time."
Earlier this year, some Republicans in the House of
Representatives embraced the Taylor rule as one they would like
the Fed to follow. Fed Chair Janet Yellen - who used to run the
San Francisco Fed - has balked at the idea. The San Francisco
Fed paper did not mention the Republican proposal.
Taylor, contacted by Reuters about the research, said he
"completely" disagrees with both its premise and its
conclusions, arguing that the authors use a version of his rule
that over-emphasizes the importance of economic slack.
He also rejected as "silly" the argument that because there is
uncertainty over the amount of slack in the economy that
monetary policymakers should just jettison the rules.
"Uncertainty exists in the real world; you can't ignore it
whether you use rules or discretion," Taylor said.
For much of the time since the Great Recession, policymakers
consulting the Taylor rule concluded it prescribed a deeply
negative policy rate. Since negative interest rates are
difficult to engineer, the Fed resorted to unconventional
methods of policy easing, including massive bond-buying
programs.
The Fed wound down its latest bond-buying stimulus last month,
but is not expected to begin to raise rates from their current
near-zero levels until the middle of next year.
Monday's research suggests that even if the Fed adopted the
Taylor rule, there still could be room for doubt as to what
interest rate it prescribes.
(Reporting by Ann Saphir; Editing by Paul Simao and Andrea
Ricci)
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