Introduction
This report asks whether current Federal Reserve policy matches what one would expect from a Taylor rule—and what “following the Taylor rule” now actually means. We begin by tracing how the rule’s core ingredients (inflation measure, output-gap weight, and r*) have been redefined, and how those recalibrations change the diagnosis of past and present policy. We then examine how markets and policymakers use multiple Taylor variants and evolving r* estimates to interpret the Taylor gap and anchor expectations. Finally, we assess whether the Taylor rule remains the right standard in a shifting labor market, highlighting systematic, crisis‑driven departures and their employment implications.
Across the materials, the Taylor rule emerges less as a fixed formula and more as an evolving benchmark whose implications for current policy hinge on three moving pieces: (1) how the rule itself is specified (inflation measure, output-gap weight, interest-rate smoothing), (2) how key unobservables such as the natural real rate of interest (r*) and potential output are estimated, and (3) how the Fed balances rule-like behavior against broader objectives—financial stability, labor-market healing, and distributional concerns—especially in crises.
Over time, Federal Reserve practice and academic work have converged on modified Taylor-rule calibrations that differ meaningfully from Taylor’s original 1993 specification. The inflation concept has shifted from GDP or CPI-style measures to PCE, and often core PCE, reflecting both its centrality in the Fed’s framework and its better performance as a gauge of underlying inflation [1][2]. At the same time, the coefficient on the output gap has been raised from Taylor’s original 0.5 to around 1.0 in what is now widely termed the “balanced-approach” rule [1][2]. Under this configuration—r* closer to contemporary estimates, core PCE as the inflation measure, and a larger weight on real activity—historical deviations between the actual federal funds rate and rule prescriptions look much smaller. Notably, analyses that adopt these updated parameters find that the canonical “too-easy” 2003–05 episode largely disappears once data revisions and the new calibration are taken into account [2]. This underscores that whether policy appears “too tight” or “too easy” is highly sensitive to the chosen variant of the rule.
The intercept term in the Taylor rule, originally tied to a 2 percent real neutral rate, has also been reinterpreted in light of a broad re‑anchoring of r* lower. A recent Federal Reserve speech reports a median model-based estimate for the real neutral rate around 1.3 percent, with a plausible range of 1–2 percent [1]. This aligns with research and tools that incorporate multiple r* measures—Laubach–Williams, Holston–Laubach–Williams, Lubik–Matthes, and longer-run FOMC projections—directly into Taylor-style prescriptions [3][4]. Using r* ≈ 1.3 percent, together with observed PCE inflation and estimates of the natural unemployment rate, standard and balanced-approach rules imply current nominal funds rates in the high‑3 percent range, close to where the FOMC has actually set policy [1]. When markets or commentators instead use the original 2 percent r* assumption, current policy may look unduly restrictive; once r* is updated, the apparent “Taylor gap” narrows, suggesting policy is closer to neutral and more consistent with a rule-based framework than a static benchmark would imply.
The balanced-approach rule, with its higher output-gap coefficient, has taken on particular importance in periods of rapid changes in labor-market slack. Historical studies and policy commentary show how this more aggressive rule rationalized very low or even negative rule-implied rates during the post‑2008 and COVID‑19 episodes, justifying the use of unconventional policies such as quantitative easing when the effective lower bound constrained the funds rate [2][5]. In the current environment, analysts use this variant to interpret the Fed’s response as the labor market cools from a tight post-pandemic position: a higher weight on slack makes implied policy rates more sensitive to indicators such as unemployment, participation, and broader measures of underutilization, not just inflation [2][4]. For asset pricing and expectations, this shift means the expected policy path hinges critically on real-side data, and a given funds rate may be consistent with a wide corridor of rule-based prescriptions depending on assumptions about slack, TFP, and sectoral shocks.
The operational infrastructure for rule-based comparisons has improved in parallel. The Atlanta Fed’s Taylor Rule Utility illustrates the institutionalization of these ideas: it allows users to swap across inflation concepts (headline vs. core PCE, projections vs. actuals), adjust the weight on the output gap, add interest-rate smoothing, and embed different r* estimates, including those implied by FOMC participants’ longer-run funds-rate and PCE projections [3]. This acknowledges explicitly that a single “Taylor rule” is insufficient; instead, there is a family of plausible rules whose prescriptions define a range for systematic policy. Research on flexible inflation targeting and average-inflation-targeting variants further codifies how inertia and history dependence enter the decision function, explaining why the Fed may systematically tolerate deviations from simple Taylor prescriptions—particularly near the lower bound or following large sectoral disturbances [5].
Nonetheless, long-span empirical work highlights persistent and sometimes large departures from even enriched Taylor rules, especially around crises and regime shifts. Studies of 1960–2024 show that in “normal” times the actual funds rate tracks baseline Taylor prescriptions reasonably closely, but diverges sharply during episodes such as the Volcker disinflation, the global financial crisis, and the COVID‑19 shock [3][5]. During 2008 and 2020, for example, the rule would have prescribed deeply negative rates; constrained by the ELB, the Fed held rates at zero and used balance-sheet tools instead, creating large negative Taylor gaps if one focuses on the policy rate alone [3][5]. Qualitative analyses link these deviations not merely to noise or error, but to additional objectives and constraints—financial stability, consumer sentiment, political economy, and leadership style—that are not captured by simple functions of inflation and the output gap [1]. Even augmented rules incorporating unemployment, PCE inflation, consumer sentiment, and interest-rate smoothing fail to fully explain all policy episodes, suggesting intentional departures that reflect changing philosophies and the salience of tail risks [1].
A critical limitation of Taylor-style benchmarks is their dependence on unobservable inputs such as potential output, the natural rate of unemployment, and r*. Historical experience illustrates how mismeasurement of these concepts can lead a rule to validate policy mistakes rather than correct them. In the 1960s–70s, overly optimistic assessments of potential output contributed to chronically loose policy and high inflation; applying a Taylor rule based on those mismeasured gaps would not have solved the problem, because the rule’s performance could be no better than its inputs [1]. Similar concerns arise around 2021, when a misreading of maximum employment and post-pandemic labor-market dynamics is argued to have contributed to overly easy policy and a subsequent inflation surge, with disproportionate effects on more vulnerable households [1]. This raises doubts about using the original Taylor rule as the authoritative standard in an economy characterized by structural changes in participation, technology, bargaining power, and sectoral composition.
Fed communications now treat Taylor-type rules as useful benchmarks rather than rigid prescriptions. The Monetary Policy Report explicitly notes that simple rules omit many factors the FOMC considers, including financial conditions, international developments, risk-management considerations, and asymmetries around the ELB [5]. It also documents how unadjusted rules would have called for sharply negative rates during ELB episodes, which was infeasible; adjusted variants are therefore constructed to reflect the cumulative shortfall in accommodation, implicitly recognizing the need to bend rule adherence to uphold the dual mandate, especially the maximum-employment leg and to mitigate scarring [5]. In addition, Fed strategy work around average inflation targeting integrates tolerance for systematic deviations from simple rules when inflation has run persistently below target, further institutionalizing the idea that the Committee will not mechanically follow any single formula [5].
Pulling these threads together, the alignment between current Federal Reserve policy and the Taylor rule is conditional. When the rule is specified with contemporary ingredients—core PCE inflation, a lower r* around 1–1.5 percent, an output-gap coefficient near 1.0, and some interest-rate smoothing—recent and current policy settings for the federal funds rate often fall within or close to the implied range of rule-consistent values [1][2][3][4]. To that extent, policy can be described as broadly “Taylor-consistent,” especially in non-crisis periods. However, the very choice of parameters and inputs is itself a moving target, shaped by evolving estimates, data revisions, and changing views about the structure of the economy. Around crises, turning points, and in the presence of severe uncertainty about slack and r*, the Fed has repeatedly and deliberately deviated from simple Taylor prescriptions, prioritizing financial stability, labor-market healing, and distributional considerations over strict rule adherence. In practice, then, the Taylor rule functions less as a single, fixed standard and more as a flexible reference set—one that informs policy debates and external assessments, but that is routinely adapted, supplemented, or overridden to reconcile price stability with broad-based and sustainable employment.
Conclusion
Across these sections, the report shows that judging today’s federal funds rate against a single, fixed Taylor rule is misleading. The “standard” rule has itself been recast—shifting to PCE inflation, raising the output‑gap weight, and embedding evolving r* estimates—so apparent past and present “deviations” largely depend on the chosen calibration. Long‑span evidence confirms that policy broadly tracks Taylor‑style benchmarks in normal times but diverges sharply in crises and around the ELB, reflecting financial‑stability and labor‑market concerns. In a changing labor market, the Fed’s own documents reinforce that rules are useful reference points, not binding constraints, and that credible policy necessarily lives in a corridor of Taylor‑consistent guidance plus informed discretion.
Sources
[1] International Finance and Banking, Vol. 11, No. 1 (2025). “Taylor Rule, Output Gap, Inflation, Unemployment Rate, Personal Consumption Expenditure Chain-type Price Index, Consumer Sentiment.” https://www.macrothink.org/journal/index.php/ifb/article/download/22746/17491
[2] “The Taylor Rule: A Benchmark for Monetary Policy.” Brookings Institution. https://www.brookings.edu/articles/the-taylor-rule-a-benchmark-for-monetary-policy/
[3] Federal Reserve Bank of Atlanta, Center for Quantitative Economic Research. “Taylor Rule Utility.” https://www.atlantafed.org/cqer/research/taylor-rule
[4] Federal Reserve Bank of Richmond, Economic Brief 24-36 (2024). “The Natural Rate of Interest (r*): Measurement and Uncertainty.” https://www.richmondfed.org/publications/research/economic_brief/2024/eb_24-36
[5] SHS Web of Conferences (ICFMDE 2025). “Evaluating the Alignment of U.S. Federal Funds Rate Decisions with the Taylor Rule, 1960–2024.” https://www.shs-conferences.org/articles/shsconf/pdf/2025/16/shsconf_icfmde2025_04016.pdf
[6] https://www.federalreserve.gov/newsevents/speech/miran20250922a.htm
[7] https://www.aeaweb.org/conference/2023/program/paper/EsFe3hG3
[9] https://www.federalreserve.gov/econres/feds/files/2025072pap.pdf
[10] Jón Steinsson, “The Taylor Rule.” https://eml.berkeley.edu/~jsteinsson/papers/Taylor_Rule.pdf
[11] Merriam‑Webster, “Standard.” https://www.merriam-webster.com/dictionary/standard
[12] Cheng Cao, “Federal Reserve Monetary Policy under the Taylor Rule: Theoretical Framework, Empirical Analysis, and Deviations.” https://www.shs-conferences.org/articles/shsconf/pdf/2025/16/shsconf_icfmde2025_04016.pdf
[13] Board of Governors of the Federal Reserve System, Monetary Policy Report (June 20, 2025). https://www.federalreserve.gov/monetarypolicy/files/20250620_mprfullreport.pdf
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