This graph shows the Taylor Rule, which is a simple formula that John Taylor devised to guide policymakers. It calculates what the federal funds rate should be, as a function of the output gap and current inflation. Here, we measure the output gap as the difference between potential output (published by the Congressional Budget Office) and real GDP. Inflation is measured by changes in the CPI, and we use a target inflation rate of 2%. We also assume a steady-state real interest rate of 2%. These are a lot of assumptions, and you are welcome to change them on the graph by playing around with the formula to see how the Taylor Rule matches up with the effective federal funds rate. To read up on the Taylor Rule, see the original article or an article by former St. Louis Fed president William Poole.
How this graph was created: To create a new series from several series, first add the series by modifying the existing series in the “Graph” tab. Once you have assembled them all, expand the series section in the same tab and “create your own transformation.” Finally, as the axis legend has become unwieldy, remove it by checking off the mark in the graph tab.
Suggested by: Christian Zimmermann