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Adjusting the Taylor Rule for the Unemployment Rate Bias by Jared Bernstein

There are various different rules and techniques for estimating the optimal FFR (Federal Funds Rate), but John Taylor’s rule is probably the most common.*

*Janet Yellen’s recent “optimal control” work is also gaining prominence in this space.  By simulating a path toward a goal like full employment, optimal control techniques return both a path for the FFR and inflation (other variables could easily be included but these are the key ones).

See the figures on pages 28-30 from this Yellen paper.  Relative to various Taylor rules, the technique allows inflation to temporarily exceed the target rate (2%) as the unemployment rate falls (I should note that optimal control assumes inflation expectations remain well-anchored, an assumption that will produce agita for some price hawks).

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