3 Sometimes it can be much higher than 2 percent. Presumably, this was the case during the late 1990s as rapid technological change lifted productivity growth. Sometimes it can be well below 2 percent. For example, when credit availability dried up during the financial crisis in late 2008, this drove down the equilibrium real rate far below 2 percent. More recently, the slow growth rate of the economy and the low rate of inflation are evidence that the equilibrium real short-term rate today is well below the 2 percent rate assumed in the Taylor Rule. If 2 percent really was consistent with a neutral monetary policy, then the very low real rates of recent years – buttressed by our large-scale asset purchases – should have been extraordinarily accommodative. As a result, we should have grown much faster than the 2½ percent pace evident over the past couple of years and seen an inflation rate much higher than what we experienced. This conclusion is supported by a number of more formal models. For example, the Laubach-Williams model currently estimates that the equilibrium real short-term rate is around zero percent. 4 Third, the Taylor Rule – and more broadly, any prescriptive rule for the systematic quantitative adjustment of the policy rate to changes in intermediate policy inputs such as real GDP or inflation – is incomplete because it does not fully account for factors that are crucial to how monetary policy impulses are transmitted to the real economy.
Second, the Rule has the desirable feature that when economic shocks push the economy away from the central bank’s objectives, the Taylor Rule prescribes a policy response that can help push the economy back toward the central bank’s goals. Third, a number of studies have shown that Taylor Rules are robust in the sense that they generally perform quite well across a range of different assumptions about how the economy is structured and operates. Despite these attractive features, I don’t believe that any prescriptive rule, including the Taylor Rule, can take the place of a monetary policy framework that incorporates the FOMC’s collective assessment of the large number of factors that impact the economic outlook. 1  Jonathan McCarthy, Paolo Pesenti, Argia Sbordone and Joseph Tracy assisted in preparing these remarks. BIS central bankers’ speeches  1  As I see it, the Taylor Rule has several significant shortcomings that can be detrimental to the attainment of the Federal Reserve’s mandated objectives. These shortcomings are not just theoretical; they have been very relevant to monetary policy in recent years. First, the Taylor Rule is not forward-looking. Its policy prescription is based on the current size of the output gap and the deviation of current inflation from the Fed’s objective, not on how these variables are likely to evolve in the future.