Fed Funds and Taylor Rules

Two methods to view Taylor Rules. The first, 0.5 in the first formula is employed as the Coefficient to hold the balance throughout the full calculations. Current Inflation is also employed rather than the second method to use 1.5 and Inflation Target of 2.0%. Both are valid as a view into not only Fed Funds and levels but the Output Gap measured by GDP minus GDP is at current 0.2 and matches Inflation at 0.2. The Out Put Gap at 0.2 is extraordinarily low.
To use the 90 day rate at 0.51 for the first formula then current Fed Funds should be at 0.69 and close to the current 0.66 close price over the past months. To use actual 0.66 Fed Funds then the current rate should be located at 0.84. The range overall, 0.69 to 0.84.
To use the second method as is the way for the RBNZ at 1.5, the 2.0% target and 90 day interest rate then FED Funds should be targeted at 0.46. What 0.46 represents is support for the 1 month interest rate as it closed today at 0.48. This is Yellen’s Floor for Fed Funds and must rise to see any shot to raise. But the Output Gap must move higher.
Here’s what we’re working with in the first method. Current PCE + 0.5 X ( Inflation minus Inflation) + 0.5 X ( GDP Minus GDP) + Interest Rate. Inflation 1.6 minus Inflation 1.4 = 0.2 while GDP 1.9 minus GDP 1.7 = 0.2. Today’s 90 day close at 0.51 factored offers Fed Funds at 0.694 while actual Fed funds used offers 0.84. . For context, the 10 year real yield factors to 0.88 while 10’s minus 2’s equals 1.27. The 10 Year minus 3 month 1.97. Doesn’t speak much regarding a raise anytime soon.

The second Method Fed Funds target = 90 day + Inflation target + 1.5 X (Inflation minus Inflation) + 0.5 X ( GDP Minus GDP ). Here we have Fed Funds at 0.46 so overall range 0.46 to 0.84.


Brian Twomey, Inside the Currency Market, btwomey.com