Home > Business Cycles, Government, Monetary Policy > Gasp!!!: An Example of Good Economic Policy by the House

Gasp!!!: An Example of Good Economic Policy by the House

I know – you are wondering if there is a misprint in the title. While I have been a frequent critic of economic policy by the government, I am here to write about an example of good behavior by the House of Representatives. Specifically, a bill has been introduced (read BILLS-113-hr5018-10-pages) which would require a policy rule to be used by the Fed as it conducts monetary policy.

Economists have devoted a great deal of research to the study of rules-based policymaking by the monetary authorities. Here is an example of a rule that might be used.

i = π + .5·(Y – YP)/YP + .5·(π – 2) + 2

In the above equation, i is the interest rate controlled by the Fed (such as the Federal Funds rate), π is the inflation rate, and YP is the level of real output at full employment. There are a number of advantages to using this rule.

One advantage is that it makes clear what the Fed targets. Here the targets are full-employment output (sometimes called Potential GDP), and the rate of inflation.

A second advantage is that the public would know what the values for the targets for Potential GDP and inflation.

Finally the rule establishes what the Fed would do if inflation and Potential GDP deviate from their targets.

By publishing this rule, the Fed would be completely transparent to the public which is a remarkable departure from the past. In addition there is research suggesting that the economy will exhibit better performance if the Fed uses such a rule.

The House bill allows the Fed to depart from this rule if circumstances require it to do so. But the Fed would need to justify its departure to Congress and the public.

Actually, the rule given above is known as the Taylor Rule, named after economist John B. Taylor of Stanford University (his blog is Economics One which is linked on this blog). Professor Taylor has done a considerable amount of research on the effects of policy rules in aggregate economies.

The House got it right by considering this new bill requiring the use of a policy rule by the Fed.

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  1. July 30, 2014 at 3:18 PM

    I would be surprised if members of the house could understand that equation. –John Sase

  2. Ross
    October 27, 2015 at 11:15 AM

    I wish I could share some of this knowledge with my friends on facebook

    • October 28, 2015 at 11:20 AM

      As far as I know, this is being posted to Facebook. Does that help?

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Economics One

A blog by John B. Taylor

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One economist's views on economic policy.

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