This is a song about the Taylor rule.First, some definitions: Interest rates and inflation are measured in percentage points. 1 percentage point means 1 percent per year. A basis point is one hundredth of a percentage point,so half a percentage point is 50 basis points. The real interest rate is equal to the nominal interest rate minus inflation.The natural level of output and the natural interest rate r-star are the long run levels of output and the interest rate. There is no natural rate of inflation, but there *is* a target rate of inflation. The difference between log output and lot natural output is the output gap in Platonic percent. Nothing the Fed does can sustain a departure from these natural levels forever. So the Taylor rule has to be at r-star when the output gap is zero and inflation is on target The Taylor rule then says the target real rate is above r-star by half of how much actual inflation is running above target inflation plus half a percentage point higher for every percent of output gap. If inflation is below target and the output gap is negative, the target real rate will be below r-star. The Taylor rule is a description of monetary policy during the Great Moderation from 1984 to 2007 when monetary policy seemed to be doing a good job of stabilizing the economy. But the Taylor rule is far from the best possible monetary policy rule. There is some evidence that bigger interest rate movements would stabilize the economy even more. Miles Kimball recommends a triple-strength Taylor rule in which the target rate is above r-star by one-and-a-half times how much inflation is running above target inflation plus one-and-a-half percentage points for ever percent of output gap. Both the Taylor Rule and the triple-strength Taylor rule often imply that, even after adding inflation, the nominal rate should be below zero. Negative interest rates are needed for implementing the Taylor rule or the triple-strength Taylor rule
