﻿ Do you believe that the Federal Reserve is anticipating that inflation is rising more quickly than it actually is? – Investment Watch
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# Do you believe that the Federal Reserve is anticipating that inflation is rising more quickly than it actually is?

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by TankHappy

The federal reserve is increasing rates to the recommendation of an economic thoery called Taylor’s Rule. While this rule isn’t always perfectly followed it does show whether to increase or decrease rates. It is a theory that observes output gaps and inflationary gaps in attempt to hit targets. Let me show you how it works and the current target rate according to this rule.

The formula: Federal Funds rate = r* + pi + 0.5 (pi-pi) + 0.5 ((100(y-y)/y*))

Definitions: r*= 2% why .5?= .5 is used to show which one the fed finds more important to target, inflation or output gaps. Other Central banks have different values. For example in Europe they focus more on Inflation so the values might be closer to .75 and .25. It all depends on what is more important. Historically speaking the FED has been found to keep these around .5 for both. This also might explain why other economists or organizations have different opinions based on how they define these values.

pi= 2.4% current inflation rate

pi*= 2% target inflation rate( according to the federal reserve’s reports we been targeting 2% for almost a decade)

Y= output GDP

Y*= potential output or GDP

Now I replace output with unemployment from the idea of Okun’s law, which is used to predict output changes based on changes in unemployment. It states for every 1% increase in unemployment it decreases output by 2% until we reach natural unemployment. Not to break out into another theory but the idea is not everyone should be employed and there is a natural level of unemployment level where output is actually decreased due to too much employment. Okun’s law is found using y-y/y= -2(u-u*).

Definitions: u= 4.1% (unemployment) u*= 4.6%(target or natural rate of unemployment. Not known but estimation)

So let’s write out the equation and solve with Okun’s law inserted.