A modernized version of the Taylor rule suggests keeping the fed funds rate target near current levels through 2021, Federal Reserve Bank of St. Louis President James Bullard said Thursday.
The modernized monetary policy rule employs a short-term real interest rate, reduces “the feedback parameter from the real economy to inflation by a factor of 10” and replaces “the inflation gap with an inflation expectations gap,” Bullard told the Economic Club of Memphis, according to text released by the Fed.
In a graph shown during his presentation, the fed funds rate appeared under 2% through 2021.
By making these changes, the “rule recommends a relatively subdued policy rate path over the forecast horizon — similar to the St. Louis Fed’s recommended path in the [Summary of Economic Projections].”
By contrast the original Taylor rule would raise rates to nearly 6% in that span, while the SEP projection is just under 3.5% through 2021.
The adjustments, Bullard said, are needed as “time, three important macroeconomic developments have altered key elements of policy rule construction” since the Taylor rule was created in 1999. Short-term real interest rates are lower, the Phillips curve doesn’t seem to apply and improvements were made in measuring inflation expectations.
“Incorporating these developments yields a modernized policy rule that suggests the current level of the policy rate is about right over the forecast horizon,” Bullard noted.
