Taylor Rule v QE3

Cross ref


QE3 v Taylor Rule

Many in the financial circle feel it is untenable for the interest rates to remain at zero.   According to the Taylor Rule, the Fed Funds rate should be at least 1%: here is why:

Tyler Durden's picture

Submitted by Tyler Durden on 06/01/2011 09:58 -0400

A month ago, Zero Hedge first posted (well, technically we read it at Stone McCarthy but beat everyone else to copying and pasting it first), that according to the Taylor Rule, so widely abused by the lemming central planners in the Marriner Eccles building, the effective Fed Funds rates should, for the first time since the GFC, be positive. This is what SMRA said: “For the second consecutive quarter, the original-specification, quarterly version of the Taylor rule, based on real GDP figures and the GDP price deflator, produced a positive result. The previous day, the BEA released its advance estimate for real GDP figures in Q1 2011. Based on those numbers, the Taylor rule prediction for the federal funds rate target in Q1 2011 is +0.4%. In the previous quarter of Q4 2010, the Taylor rule prediction was +0.1%.”

Now, Taylor himself, in his blog, confirms that not only should the Fed Funds rate be positive, it should be 1%.

  • Over here at Economics One, I can report that the Taylor Rule says that the fed funds rate should now be 1 percent, and I can provide the calculations. Available data (through the 1st quarter) show that the inflation rate is about 1.6 percent (GDP deflator smoothed over four quarters) and the GDP gap is about 4.8 percent (average of San Francisco Fed survey). This implies an interest rate of 1.5 X1.6 + .5X(-4.8) + 1 = 2.4 – 2.4 +1 = 1.0 percent. I am not sure why other reports differ, but at least the coefficients and numbers are here to see and check. Perhaps they are using different coefficients, but David Papell writing at Econbrowser earlier this month showed why the coefficients reported here work well.
  • So I think the economy would be better off if the Fed started moving to a higher funds rate now rather than later, and I certainly see no rationale for another round of quantitative easing. Unfortunately, it looks like the Fed will continue with its zero interest rate for a while longer, and traders will continue to debate whether or not there will be a QE3 adding volatility to the market.

It is ironic, then, that Taylor speaks up just in time for Jan Hatzius and Bill Dudley to start their behind closed doors meetings which will usher in QE3. After all, we have now gotten to the point where Hank Paulson will be brought out of retirement and paraded in front of Congress waving a 3 page term sheet demanding a blank check should the Russell 2000 retrace below the 100 DMA.

IDkit, Ag Moderator

1 thought on “Taylor Rule v QE3”

  1. James M. Buchanan, the 1986 Nobel Prize Winner, wrote in “Economists Have No Clothes” that:

    “Economists have rarely claimed the role of kings, and, in many respects,
    they recognize their own limitations. Nonetheless, economists must appreciate
    the waste of massive intellectual energy as their best and brightest have chased
    intellectual puzzles that emerge from a flawed abstract understanding. It is little
    wonder that so much of what economists have said, and say now, is exposed as
    irrelevant and essentially useless.”

    Hey, Taylor Rule is different? 🙂

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