Taylor rules and the inflation surge: The case of the Fed

Balint Tatar and Volker Wieland

No 201, IMFS Working Paper Series from Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS)

Abstract: The Federal Reserve has been publishing federal funds rate prescriptions from Taylor rules in its Monetary Policy Report since 2017. The signals from the rules aligned with Fed action on many occasions, but in some cases the Fed opted for a different route. This paper reviews the implications of the rules during the coronavirus pandemic and the subsequent inflation surge and derives projections for the future. In 2020, the Fed took the negative prescribed rates, which were far below the effective lower bound on the nominal interest rate, as support for extensive and long-lasting quantitative easing. Yet, the calculations overstate the extent of the constraint, because they neglect the supply side effects of the pandemic. The paper proposes a simple model-based adjustment to the resource gap used by the rules for 2020. In 2021, the rules clearly signaled the need for tightening because of the rise of inflation, yet the Fed waited until spring 2022 to raise the federal funds rate. With the decline of inflation over the course of 2023, the rules' prescriptions have also come down. They fall below the actual federal funds rate target range in 2024. Several caveats concerning the projections of the interest rate prescriptions are discussed.

Keywords: Monetary policy; interest rates; Federal Reserve; Taylor rule; New Keynesian macroepidemic models (search for similar items in EconPapers)
JEL-codes: E42 E43 E52 (search for similar items in EconPapers)
Date: 2024
New Economics Papers: this item is included in nep-ban, nep-cba and nep-mon
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