Taylor Rule vs. Federal Funds Rate

The Taylor Rule is meant to predict an appropriate level for the Federal Funds Rate (FFR) as set by the US Federal Reserve.  The chart below compares the Taylor Rule to the FFR from 1971 to 2011.

The FFR seems to lag the Taylor Rule in the 1970′s.  From the mid-80′s till around 2002, the two figures never diverge significantly from one another.  However, from 2002 to 2006, the two figures seem to drift apart from one another.  This connection is amplified using our Alternative CPI method of calculating the Taylor Rule.

The second chart is the same as the first, except it shows the difference in results between the Taylor Rule and FFR.  For instance, if the Taylor Rule predicts an FFR of 10% and the true FFR is 5%, there is a +5% differential, and the Taylor Rule suggests that monetary policy is too loose.