Chart of the Day: February 23, 2023
Must the Fed tighten far more to tame inflation?
Today will be quick. We’re going to take a look at a common measure often used by central bankers as a guide for where short term interest rates need to be to achieve policy objectives — The Taylor Rule.
Here is a quick description of The Taylor Rule from Investopedia:
“The Taylor Rule (sometimes referred to as Taylor's rule or Taylor principle) is an equation linking the Federal Reserve's benchmark interest rate to levels of inflation and economic growth. Stanford economist John Taylor originally proposed the rule as a rough guideline for monetary policy”
In other words, The Taylor Rule tells the Federal Reserve where to set their benchmark interest rate in order to achieve their inflation and growth objectives.
Figure 1 is brought to us by Lyn Alden Investment Strategy. The chart shows the effective federal funds rate vs the Taylor Rule’s suggested rate.
Historically, the Taylor Rule has been a valuable tool — especially when judging how high rates need to go to tame a significant inflationary episode.
The Taylor Rule’s now suggesting an effective federal funds rate in the neighborhood of 10% is needed to permanently reduce inflation back to the Fed’s policy target of 2%.
Are we destined to a much higher interest rate environment than the market’s are pricing in?
— Brant
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