"Taylor Rule and Inflation Targeting" - Coursework Example

Taylor Rule and Inflation Targeting al Affiliation) Taylor Rule and Inflation Targeting The Taylor rule asserts that the Federal Reserve relies on the estimated economy’s unutilized resources and inflation behavior to allocate funds rate (Hetzel, 2000). Taylor rule offers recommendations on how the Federal Reserve can address short-term economic changes and long-term inflation by setting short-term interest rates. Apparently, this rule is not an effective guide of economic policy. This emanates from the fact that the rule seeks to recommend how the Federal Reserve should control inflation instead of preventing it from occurring (Hetzel, 2000).

Indeed, the rule reckons how the Federal Reserve System has raised the funds rate in responding to inflation. Moreover, the rule recognizes an output gap and observed inflation where the Federal Reserve manipulates the output gap to control inflation (Hetzel, 2000). However, there is uncertainty on whether the Taylor rule can offer fundamental explanation on future inflation rates especially in America.On the other hand, the central bank can use inflation targeting as a monetary policy. Inflation targeting influences the economy since it controls increase in price levels (Jahan, 2015).

Indeed, if central bank in the U.S. used inflation targeting, it would declare a target inflation rate and seek to control the actual inflation toward the target inflation by regulating interest rates, which would consequently influence price levels. This will equally lead to a transparent monetary policy since the interest rates changes adopted by the central bank will foster clear and opposite inflation rates (Jahan, 2015). As such, under inflation targeting policy, the American economy would be more transparent and increasingly stable.

The use of inflation targeting by the central bank in U.S would enable the economy to respond to economic shocks in the short run since inflation targeting entails “rules” and “discretion” in monetary policy (Jahan, 2015).ReferencesHetzel, R. L. (2000). The Taylor Rule: Is It a Useful Guide to Understanding Monetary Policy? Retrieved from https://www.richmondfed.org/-/media/richmondfedorg/publications/research/economic_quarterly/2000/spring/pdf/hetzel.pdfJahan, S. (2015). Inflation Targeting: Holding the Line.

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