Question

How does Taylor Rule and monetary policy correlate?

Answer 1

Answer.

The Taylor Rule suggests that the Federal Reserve should raise rates when inflation is above target or when gross domestic product (GDP) growth is too high and above potential. It also suggests that the Fed should lower rates when inflation is below the target level or when GDP growth is too slow and below potential.

• Firstly, it relates policy setting systematically to the state of the economy in a way that, over time, will produce reasonably good outcomes on average.
• A second benefit of simple rules is that they help financial market participants form a baseline for expectations regarding the future course of monetary policy.
• A third benefit is that simple rules can be helpful in the central bank’s communication with the general public. Such an understanding is important for the transmission mechanism of monetary policy.

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