What the Taylor Rule Calculator does
The Taylor Rule is a monetary-policy guideline, proposed by Stanford economist John Taylor in 1993, that recommends a nominal short-term interest rate — historically framed around the U.S. federal funds rate — from three ingredients: how far inflation sits from its target, how far the economy's output sits from its sustainable potential, and an estimate of the "neutral" real interest rate that neither stimulates nor restrains growth. This calculator applies the standard formula directly to the numbers you enter.
The formula
i = r* + π + aπ(π − π*) + ay(y)
Where i is the recommended nominal policy rate, r* is the equilibrium real interest rate, π is current inflation, π* is the inflation target, y is the output gap (the percent by which actual GDP sits above or below potential GDP), and aπ / ay are response weights that control how aggressively the rate reacts to each gap. Taylor's original 1993 paper set r* = 2%, π* = 2%, and aπ = ay = 0.5 — those are the calculator's defaults, and every field can be adjusted to test other assumptions or later variants of the rule.
Worked example
With the defaults — 3% inflation, a 2% target, a 0.5% output gap, a 2% neutral real rate, and 0.5 weights on both gaps — the rule computes: inflation-gap contribution = 0.5 × (3 − 2) = 0.5, output-gap contribution = 0.5 × 0.5 = 0.25, so the recommended rate is i = 2 + 3 + 0.5 + 0.25 = 5.75%. Subtracting current inflation gives an implied real policy rate of 5.75 − 3 = 2.75%.
Reading the gaps
- Inflation gap (π − π*): positive when inflation runs above target, which pushes the recommended rate up to cool price growth; negative when inflation is below target, pulling the recommended rate down.
- Output gap (y): positive when the economy is producing above its estimated potential (typically associated with a tightening labor market), which also raises the recommended rate; negative when output is below potential, lowering it.
- Response weights (aπ, ay): larger weights make the recommended rate react more sharply to each gap. Some later variants — notably the "Taylor 1999" rule — raise ay toward 1.0 for a more activist response to economic slack.
Limitations to keep in mind
The Taylor Rule is a benchmark, not a forecast or a binding formula. The neutral real rate and the output gap are themselves estimates that economists revise over time and often disagree about, so the calculator's output changes with the assumptions you feed it. Central banks weigh the rule alongside financial-stability risks, employment data, credit conditions, and forward guidance — they do not mechanically set rates to match it. Treat the result as a transparent reference point for understanding the logic of rules-based monetary policy, not as investment or policy advice.