Taylor's Rule

DEFINITION of 'Taylor's Rule'

A guideline for interest rate manipulation. Taylor's rule was introduced by Stanford economist John Taylor in order to set and adjust prudent rates that will stabilize the economy in the short-term and still maintain long-term growth. This rule is based on three factors:

1) Actual versus targeted inflation levels
2) Actual employment versus full employment levels
3) The appropriate short-term interest rate consistent with full employment.

BREAKING DOWN 'Taylor's Rule'

Taylor's rule suggests that the Fed increases interest rates in times of high inflation, or when employment is above the full employment levels, and decreases interest rates in the opposite situations. This method of controlling interest rates has been fairly consistent with interest policy decisions, even though the Fed does not explicitly subscribe to the rule.

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