Taylor Rule Q

Explain why the monetary action suggested by Taylor Rule may not actually be taken by central bank authorities. TIA.

Lets say that the Taylor rule suggests you drop short term rates by 1%, however the exspected inflation is currently higher than the target inflation. By dropping the rates, you are running the risk of even more inflation (possibly hyperinflation is an extreme situation). If you drop rates, the economy should be stimulated, and inflation picks up, which may not be what you want when you arleady have higher inflation/

Now, lets say that the rule tells you to increase rates, however you are currently at an output gap and yuor GDP expected is below the trend. You may end up raisin rates (to battle inflation for example), but raising short term rates usually leads to decreased economic activity, emaning GDP will dro peven more, and you could be pushed into recession or further into one.

Spanishesk, I see it from a different angle.

I believe that this is precisely the point of teh Taylor rule, that either the inflation factor or the GDP factor will “win”, depending on how much out of line they are with target.

It is said to be a good predictor, meaning that central banks tend to act upon it.

Viceroy, I agree with what you say. However I distinctly remember studying and seeing some questions where you are asked why the central bank may decide not to pursue the results of the Taylor rule. You are right, one of the two will dominate. However, theres a point where the central bank will not act because it may hurt more in the long run than help in the short term.

The taylor rule may not actually be acted upon by authorities because it neglect asset prices,fiscal policy,wage behaviour and other variables operative in an economy…

isnt taylor rule meant for short term action and might hurt in the long run?

This question was on a past paper, t had to do with rising inflation but if taylor rule predicts interst rates should fall then this would cause even greater inflation since inflation was already predicted to increase.

So the monetary rule was in conflict with the inflation prediction forecast

the reason is pretty simple. because john taylor and ben bernanke don’t get along.

i thought we were talking about Elizabeth Taylor (really) !

the girl who was freaking out abt taylor rule but then passed L3 or smthg like that ? lol

^ lol… yeah i also read that one…