I am not a great advocate of the Taylor Rule, but the Student should understand it. Here One can read the author explain it. People will want to know my reservations about the Taylor Rule, so I might as well make people laugh this morning. The economy absorbs all Inflation at all times, with Boom times pigging out on Inflation. A booming economy gives Aid and Comfort to Pricing, so much so that Inflation sprints past Consumer Demand in the constant footrace. Consumer Demand will eventually falter, and the Recession will begin. Consumers must again catch their breath, before they are ready to start the Race again; this means they need a defensible base of financial assets before they start to Consume again at rates which will produce a Boom. The key point here stands a the development of that defensible base of financial assets, which Fed intervention cannot fix, but whose efforts the Fed can certainly injure.
The real weapon used in construction of this defensible base remains to pay down their Credit levels, and to attain exterior assets through their Investment structure maintaining their own Profitability. Fed suppression of the Interest Rates incites financial institutions to pay less for Investor deposits with them, acts as a signal to Credit extension to maintain their rates rigorously, and tells production entities that they should curtail their Dividend structure. Consumers find they are alone in development of this financial base of defensible assets, often co-existing with limitations placed upon their Wages and Bonuses. And people wonder Why Recessions are slow in Recovery!
The greatest error in the Taylor Rule stands in that it chases the GDP Gap. The above information negates this Chase past a limitation point. Taylor would have the full percentage of the GDP Gap entered into the equation, when that added measure should never increase beyond 2.4 to represent the GDP Gap. Past this Number the economy suffers more injury to the Recovery powers to the economy, than is generated desire to Produce. The amended Taylor Rule, which Taylor would disapprove, would lead to 3-1.2+1, or 4-1.2=2.8 as the base Interest rate. Any Rate below this level simply injures the Recovery adjustment more than it helps. Now watch how the economists and bankers tear apart this argument, all because they are in a privileged position (they make Money) above the Inflation rate. lgl