ποΈ Taylor Rule Calculator
What the textbook says the Fed funds rate should be.
Taylor Rule implied rate
Estimates for planning only, not financial advice.
With inflation at 3 percent against a 2 percent target, a 1 percent positive output gap, and a 1 percent neutral real rate, the Taylor Rule prescribes a 5 percent federal funds rate. It is the most famous equation in monetary policy, and the Fed follows its spirit while denying it follows the letter.
How to Use This Calculator
Enter current inflation (usually core PCE, the Fed's preferred gauge), the inflation target (2 percent), the output gap (actual minus potential GDP as a percent), and your estimate of r-star, the neutral real rate. The calculator returns the rule-implied nominal policy rate.
Enter inflation and target. The gap between them drives half the prescription.
Enter the output gap: positive when the economy runs hot, negative in a slump. The CBO publishes estimates.
Set r-star, the real rate consistent with full employment and stable inflation. Near 1 percent is the modern consensus, down from 2 percent pre-2008.
The Formula
John Taylor's 1993 rule says: start with current inflation, then lean against both inflation overshoots and output gaps with equal 0.5 weights, anchored by the neutral real rate. The 0.5 coefficients satisfy the Taylor principle: the nominal rate must rise more than one-for-one with inflation (coefficient 1.5 total) so the real rate actually tightens. Anything less lets inflation accelerate.
Worked Example
Inflation 3 percent, target 2 percent, output gap +1 percent, r-star 1 percent. Rate = 3 + 0.5 x (3 - 2) + 0.5 x 1 + 1 = 3 + 0.5 + 0.5 + 1 = 5.0 percent. Implied real rate: 5 - 3 = 2 percent, a full point above neutral, meaning policy is restrictive. Flip to a recession: inflation 1.5 percent, gap -3 percent: rate = 1.5 + 0.5 x (-0.5) + 0.5 x (-3) + 1 = 0.75 percent, deeply accommodative.
How Well Does It Track the Fed?
Surprisingly well over long stretches, which is why markets watch it. The rule called for deeply negative rates in 2009-2015, explaining quantitative easing as the substitute when the zero bound bound. It prescribed aggressive hikes in 2022-2023, which the Fed delivered. Deviations usually reflect the Fed's dual mandate judgment, financial stability worries, or data the rule's four inputs miss. Treat persistent gaps between the rule and the actual funds rate as information: the Fed sees something the formula does not, or is making a policy choice the formula would not.
The r-star Problem
Every input is estimated, but r-star is the ghost. It cannot be observed, only inferred, and estimates range from 0.5 to 1.5 percent. Move r-star by half a point and the prescription moves half a point. Output gap estimates get revised for years after the fact. This is why the Fed treats the Taylor Rule as a cross-check, not autopilot: the equation is exact, its inputs are foggy. Run the calculator with r-star at 0.5 and 1.5 to see your uncertainty band.
Variants Worth Knowing
Economists have tuned the original relentlessly. The "balanced approach" rule doubles the output gap weight to 1.0, prescribing easier policy in slumps. Inertial versions smooth rate changes quarter to quarter, matching the Fed's gradualism. Price-level targeting versions respond to cumulative misses, not just current inflation. All share the skeleton: inflation gap plus output gap plus neutral rate. For the household side of rates, our APR calculator translates policy rates into what borrowing actually costs you.
Where the Taylor Rule Breaks
The rule's weak link is r*, the neutral real rate: unobservable, estimated, and possibly drifting. If r* has fallen from 2 percent to 1 percent, as many economists believe, the classic calibration overprescribes rates by a full point. The Fed's own Laubach-Williams estimates move with the data, which means the Taylor prescription moves with them; a rule built on a moving estimate is guidance, not autopilot.
The zero lower bound is the second break. When the rule prescribes negative 3 percent, the Fed cannot cut there, so it substitutes forward guidance and quantitative easing, tools the rule never mentions. That is why the 2010s saw rates pinned at zero while Taylor-rule charts screamed for deeply negative rates. Use the rule as a benchmark for "is policy tight or loose relative to history," not as a prediction of the next FOMC vote.
A Compass, Not a GPS
The Taylor rule tells you which direction rates should move and roughly how far; it was never meant to set policy mechanically. Central banks smooth changes, weigh financial stability, and sometimes face supply shocks the rule misreads. Use it the way economists do: as the benchmark that makes deviations informative. When the Fed holds rates far from the Taylor prescription, ask why: the answer is usually the most interesting thing happening in monetary policy.
Estimates for planning only, not financial advice.
Frequently Asked Questions
What is the Taylor Rule?
An equation prescribing the federal funds rate: the inflation rate plus half the inflation gap, plus half the output gap, plus the neutral real rate. Proposed by John Taylor in 1993, it is the benchmark economists use to judge whether Fed policy is tight or loose.
What is the Taylor Rule formula?
i = Ο + 0.5(Ο - Ο*) + 0.5(y - y*) + r*, where Ο is inflation, Ο* the target, (y - y*) the output gap, and r* the neutral real rate. With 3% inflation, 2% target, +1% gap, and 1% r-star, it gives 5%.
What is r-star?
The neutral real interest rate: the inflation-adjusted rate consistent with full employment and stable inflation. Modern estimates center near 1%, down from about 2% before 2008. It is unobservable and estimated, which is the rule's biggest source of uncertainty. If r-star is actually 0.5% rather than 1%, the rule overprescribes rates by half a point for years, a policy error hiding inside one assumption.
Does the Fed actually follow the Taylor Rule?
Not mechanically, but it tracks the rule's prescriptions closely over long periods and officials cite it as a cross-check. Deviations reflect judgment about financial stability, data uncertainty, and the dual mandate's employment leg, which the simple rule compresses into the output gap.
What is the output gap?
Actual GDP minus potential GDP, as a percent of potential. Positive means the economy is running hot (inflation risk); negative means slack (unemployment risk). The Congressional Budget Office publishes estimates, though they are revised substantially after the fact. Policymakers in 2008 thought the output gap was modest; later revisions showed it was enormous, which is why real-time Taylor prescriptions deserve humility.
What is the Taylor principle?
The requirement that nominal rates rise more than one-for-one with inflation, so real rates actually tighten. The rule's 1.5 total coefficient on inflation satisfies it. Violating it lets inflation expectations drift, which is what happened in the 1970s. When the Fed kept nominal rates flat as inflation rose in 2021, critics argued it was repeating the violation; the rapid 2022-2023 hikes were the correction.
Why did the Taylor Rule call for negative rates after 2008?
With inflation below target and a deeply negative output gap, the formula prescribed rates well below zero. Since rates cannot go much below zero, the Fed used quantitative easing as the substitute stimulus, which the rule's logic supports. Researchers estimate QE1 and QE2 delivered stimulus roughly equivalent to cutting rates 2 to 3 points below zero, closing much of the gap the rule identified.
What are the criticisms of the Taylor Rule?
Its inputs (especially r-star and the output gap) are uncertain and revised; it ignores financial stability; and mechanical use could amplify volatility. Most economists treat it as a useful benchmark and communications device, not an autopilot. The Fed itself cites Taylor-type rules in its reports while insisting policy also weighs financial conditions, global spillovers, and risk management.
How does the Taylor Rule relate to mortgage rates?
Indirectly but powerfully. The fed funds rate anchors short-term rates, which influence the 10-year Treasury, which sets mortgage rates. When the rule prescribes hikes, mortgage rates usually follow within months. Check the pass-through with a mortgage payment calculation. The 2022 hiking cycle roughly doubled 30-year mortgage rates in a year, the fastest Taylor-implied tightening most borrowers had ever seen.
What inflation measure should I use?
The Fed targets PCE inflation (2%), ideally core PCE excluding food and energy. CPI runs about 0.3 points higher on average. Using CPI in the rule without adjusting will prescribe slightly tighter policy than the Fed's own framework implies. Headlines quote CPI, but the FOMC watches PCE; when the two diverge, expect the Fed to follow its own gauge.