Monetary Policy Benchmarks

2026

March

The Taylor 1993 and Taylor 1999 rules call for higher interest rates in 2026 relative to the baseline rule. These rules don't have built-in gradualism, and, other things being constant, they place more weight on the output gap than the baseline. Consequently, they provide stronger support for output growth, leading the output gap to close faster than in the baseline. The boost to economic activity comes at the cost of higher inflation, which leads the federal funds rate to increase under these rules, peaking at the end of 2026. Even though the Taylor 1993 and 1999 rules induce nominal interest rates to rise above the baseline, the short-term real interest rate - the difference between the federal funds rate and expected inflation - is lower than in the baseline for most of the forecast horizon. This is because inflation rises faster than the nominal interest rate under these rules, resulting in a lower real interest rate. Lower borrowing costs and reduced returns on saving stimulate current demand and provide an intuitive explanation for why the output gap narrows faster and inflation is higher relative to the baseline.

Like the Taylor 1993 and Taylor 1999 rules, the inertial Taylor 1999 rule places more weight on the output gap than in the baseline, stimulating economic activity at the cost of higher inflation by inducing lower real interest rates than the baseline. Even so, the economic mechanism at play is somewhat different: Relative to the noninertial Taylor rules, the lower real rates arise from both lower nominal interest rates and lower inflation. This reflects a more favorable trade-off between output and inflation under this rule because private-sector expectations adjust: Under the inertial Taylor 1999 rule, forward-looking households and firms act on the expectation that monetary policymakers will persistently increase interest rates in response to above-target inflation. The expectation of possibly higher rates for longer brings the private economy back in line without the need to implement such a policy. Hence, the stimulus arising from a higher weight on the output gap gives rise to a more contained increase in inflation. This expectations channel allows the inertial rule to close the output gap with a smaller increase in inflation, revealing a more favorable trade-off.