Taylor rule

A guide to where the policy rate should sit: the neutral real rate plus expected inflation, plus half the gap between expected and target inflation and half the output gap. A rate above it signals tight policy.

Where you will meet it

Taylor rule appears in 2 learning outcomes on the CFA syllabus. A few of them:

• Explain how each stage of the business cycle shapes policy and short-term rates, the steepness of the yield curve, and how bonds of shorter and longer maturity perform against each other
  CFA Level II · Portfolio Construction

  “A common guide to policy is the Taylor rule, which sets the policy rate at i = neutral real rate + current inflation + 0.5 × (inflation − target) + 0.5 × output gap.”

• Explain how central bank and government budget policy influence the course of the business cycle
  CFA Level III · Asset Allocation

  “A common benchmark is the Taylor rule: target policy rate = neutral real rate + expected inflation + 0.5 × (output gap) + 0.5 × (inflation − target).”

See also

Output gap · Policy rate

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with T · Glossary