Help to remember Taylor Rule

CFA Level III
#1

well, having to remember dozens of formulas each exam and rarely using them because of all the other stuff, I try to think of helpful Eselsbruecken (memory hooks). One I figured out for the Taylor Rule target rate = neutral rate + 0,5*(GDP exp - GDP target) + (0,5*i-exp - i-trend) is E.T.-rule. First, T is also in Taylor so it should pop up in the head when you see this, second, E comes before T, i.e., the E xpected stuff comes before the substraction of T arget / T rend. Guess this is now 4-6 minutes / points safe, 354-56 to go :wink: You guys have other good hooks?

#2

Careful on the formula, it’s: Neutral + [0.5*(GDPforecast - GDPTrend) + 0.5*(Iforecast-Itarget)] CFAI uses forecast, Schweser uses expected…not important…but you’ve got the 0.5 in the wrong place in the Inflation term. NAIL IT

#3

And you flipped trend and target

#4

, . From Europe?

#5

taylor rule rocks, I hope thats on the test, doubt it though.

#6

if ur expected gdp is greater than trend then from a central bank perspective u need to raise interest rates as concerns of economy overheating if expected is greater than trend then u also need to incread interest rates to negate increaisng inflation pressures the hard part for me is to rembmber the 0.5

#7

I remember that it’s the neutral rate, plus half of the inflation gap plus half of the output gap Now you remember output gap too.

#8

Cool…move all T* together, it’ll be balanced.

#9

alsak, thanks for correcting it and excuse my mistake. with all this discussing about the formula it will now become hard not to remember it, I guess

#10

Malawyer100, you own Taylor Rule now.

#11

This is forever ago but I’m adding my two cents.

Roptimal = Rneutral + .5(GDPg_forecast - GDPg_trend) + .5(Iforecast - Itarget)

Rneutral = forecast inflation + assumed equilibrium real interest rate

GDP

  • GDPg_forecast = forecast GDP
  • GDPg_trend = highest level of real GDP (potential output) that can be sustained over long term
  • GDPg_forecast - GDPg_trend = negative output gap (output gap is potential GDP - forecast GDP)
    • If (negative output gap) > 0 = market is overheating so raise rates
    • If = 0 = do nothing
    • If < 0 = lower rates to close the output gap

Inflation

  • Iforecast = forecast inflation
  • Itarget = target inflation
  • if forecast inflation is > target inflation = raise rates.
    • Raising interest rates reduces inflation because it reduces the overall money in the economy by increase the cost to borrow. Think borrowing = leverage = ability to have goods cost more funded by leverage