Taylor Rule Calculator
Table of contents
What is Taylor rule?How to calculate federal funds rate using Taylor rule? â€“ Taylor rule calculatorWhat is the limitation of the Taylor rule formula?FAQsWe have prepared this Taylor rule calculator for you that calculates the federal funds rate. The Taylor rule depicts the relationship between the federal funds rate, the inflation rate, and gross domestic product (GDP). It is a powerful econometric model that can help you to forecast federal funds rates.
After reading this article, you will understand what is Taylor rule and how to calculate the federal funds rate. Furthermore, you will find some practical Taylor rule examples to help you understand the econometric model better.
What is Taylor rule?
The Taylor rule, also known as Taylor's principle or the federal funds target rate formula, is one of the most proficient econometric tools that can help you to predict the federal funds rate. The Taylor rule definition was published by a Standard professor named John Taylor in 1993. In his study, he assumed the federal funds rate is closely related to 3 factors:
 Real interest rate;
 Deviation of the actual inflation rate from the desired inflation rate; and
 Deviation of the actual GDP from the potential GDP.
To understand more about GDP, check out our GDP calculator.
The Taylor rule is used to determine the ideal federal funds rate, in theory, that will lead the economy into stable prices and full employment, given the current situation. The tool implies that the Federal Reserve should raise the federal funds rate, or the shortterm interest rate when the inflation and employment rates are higher than the desired level. On the other hand, the shortterm interest rate should be decreased to boost the economy if the inflation and employment rates are higher than the desired level.
Worry not if this Taylor rule definition sounds complicated. We have prepared some examples to show you how to find it.
How to calculate federal funds rate using Taylor rule? â€“ Taylor rule calculator
Now, let's take a look at a Taylor rule example. Let's take Country A, with the following data, as an example:
 Current inflation rate: 4%
 Current GDP: $2,000,000,000
 Longrun GDP: $3,000,000,000
 Nominal interest rate: 5%

Calculate the inflation rate gap.
The
inflation rate gap
is the difference between thecurrent inflation rate
and thedesired inflation rate
. For most advanced countries, thedesired inflation rate
will be2%
. As for thecurrent inflation rate
, you can get it from governmentpublished data. For the US, you can find it on the .The
inflation rate gap
can be calculated as:inflation rate gap = current inflation rate  desired inflation rate
The
inflation rate gap
for Country A is4%  2% = 2%
. 
Calculate the output gap.
The
output gap
is defined as the deviation of GDP from the desired level. It can be calculated using the following formula:output gap = log(current GDP)  log(longrun GDP)
where
log
is the common logarithm. For Country A, itsoutput gap
is:log(2,000,000,000)  log(3,000,000,000) = 9.30  9.48 = 0.18%
.You can use our log calculator to calculate this.

Calculate the real interest rate.
The
real interest rate
is defined as the interest rate adjusted by thecurrent inflation rate
. The equation to calculate it is:real interest rate = nominal interest rate  current inflation rate
In this example, the
real interest rate
will be5%  4% = 1%
. 
Calculate the federal funds target rate using the Taylor rule formula.
Now it is time for us to calculate the
federal funds target rate
. The Taylor rule equation is:federal funds target rate = real interest rate + current inflation rate + 0.5 Ã— inflation rate gap + 0.5 Ã— output gap
So plugging in the numbers from our example, that's:
1% + 4% + 0.5 Ã— 2% + 0.5 Ã— (0.18%) = 5.91%
.
Use our Taylor rule calculator to avoid all of these laborious computations!
What is the limitation of the Taylor rule formula?
Even though the Taylor rule equation can be a very powerful econometric tool, it does have its limitations:

The Taylor rule formula, or federal funds target rate formula, can provide little guidance during economic recessions. Economic recession often comes in the form of economic shocks that happen rapidly. As the Taylor rule focuses on predicting the federal funds rate using the deviation of the inflation rate and GDP from the longterm desired target, the Taylor rule does not consider sudden economic shocks.

The prediction obtained by calculating the Taylor rule equation could have little use when the GDP and the inflation rate go in different directions. The intricacies are not modeled into the Taylor rule calculation. This is particularly true when the economy is in stagflation, in which the GDP declines but the inflation rate rises. The Taylor rule can offer little help under these circumstances.
What is the federal funds rate?
The federal funds rate is the interbank interest rate controlled by the Federal Reserve. It is the interest rate that one bank needs to pay to another when it borrows money from the bank. It is also known as the shortterm interest rate.
What is the inflation rate?
The inflation rate, also referred to as the Consumer Prices Index (CPI), is the increase in the prices of goods over time. For instance, if the annual inflation rate is 5%, it means that, on average, the prices of goods have increased by 5% since last year. Governments tend to have a desired annual inflation rate of 2%.
What is the GDP?
The gross domestic product, or GDP for short, is the monetary value of all the goods and services produced and delivered by a country. The higher the GDP, the larger the economy the country represents.
What is the real interest rate?
The real interest rate is defined as the difference between the nominal interest rate and the inflation rate. It is defined as the interest rate change given the inflation rate.