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The Natural Rate of Interest in Taylor Rules

Author

Listed:
  • Charles T. Carlstrom
  • Timothy S. Fuerst

Abstract

The Taylor rule suggests that the federal funds rate should be adjusted when inflation deviates from the Fed?s inflation target or when output deviates from the Fed?s estimate of potential output. Typical formulations of the rule assume that the level of the inflation-adjusted federal funds rate that is expected to prevail in the long run, sometimes thought of as the ?natural? rate of interest, is constant over time. Since this assumption is likely incorrect, we show how the Taylor rule can account for a variable natural rate by incorporating long-term productivity growth. We also show that better monetary policy outcomes may be achieved if the Fed regularly adjusts the funds rate in response to perceived changes in productivity growth, even if these changes are often measured with error.

Suggested Citation

  • Charles T. Carlstrom & Timothy S. Fuerst, 2016. "The Natural Rate of Interest in Taylor Rules," Economic Commentary, Federal Reserve Bank of Cleveland, issue March.
    • Handle: RePEc:fip:fedcec:00045
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    Citations

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    Cited by:

    1. Mikael Juselius & Claudio Borio & Piti Disyatat & Mathias Drehmann, 2017. "Monetary Policy, the Financial Cycle, and Ultra-Low Interest Rates," International Journal of Central Banking, International Journal of Central Banking, vol. 13(3), pages 55-89, September.
    2. Anthony J Evans, 2020. "The natural rate of interest: An estimate for the United Kingdom," Economic Affairs, Wiley Blackwell, vol. 40(1), pages 24-35, February.
    3. Luis Ceballos & Jorge A. Fornero & Andrés Gatty, 2017. "Nuevas estimaciones de la tasa real neutral de Chile," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 20(3), pages 120-143, December.
    4. John B. Taylor & Volker Wieland, 2016. "Finding the Equilibrium Real Interest Rate in a Fog of Policy Deviations," Business Economics, Palgrave Macmillan;National Association for Business Economics, vol. 51(3), pages 147-154, July.
    5. Mikael Juselius & Claudio Borio & Piti Disyatat & Mathias Drehmann, 2017. "Monetary Policy, the Financial Cycle, and Ultra-Low Interest Rates," International Journal of Central Banking, International Journal of Central Banking, vol. 13(3), pages 55-89, September.
    6. repec:zbw:bofrdp:2016_024 is not listed on IDEAS
    7. Escañuela Romana, Ignacio, 2018. "Instability in the basic New Keynesian model under limited information," MPRA Paper 88015, University Library of Munich, Germany.

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