Ever heard of the Taylor Rule?
Not many people have, but the folks at the U.S. Federal Reserve are very familiar with it – and they'd probably prefer that this highly respected guideline for the federal funds rate languish in obscurity.
Basically the Taylor Rule is a mathematical equation based on inflation, output, and other economic measures. It was created in 1993 by John B. Taylor, a renowned economics professor at Stanford University.
Ordinarily, the actual Fed funds rate should track within the range of where the Taylor Rule says it should be.
And for most of the past 30 years, that's pretty much what's happened.
But since 2009, the Fed funds rate has diverged from the Taylor Rule – a divergence that's getting bigger all the time.
It's yet another signal that the Fed's easy money policies – namely keeping interest rates near zero while pouring on quantitative easing (bond-buying) that makes effective interest rates negative – are becoming increasingly dangerous the longer they go on.
If the Federal Reserve were following the Taylor Rule, it would not only need to end all QE immediately, but it would actually have to raise interest rates.
And given the outcome of today's (Wednesday's) FOMC meeting, it doesn't look like the Federal Reserve is going to change course anytime soon.
"The Committee decided to await more evidence that [economic] progress will be sustained before adjusting the pace of its purchases," the FOMC statement read.
Translation: "We think the economy still needs our help, so we're going to keep the money-printing presses running at full speed."
That means the lines on the chart above are going to continue to head in opposite directions.
"This divergence is like the 'check engine' light in your car," Money Morning Chief Investment Strategist Keith Fitz-Gerald said. "But instead of looking under the hood, the Fed is ignoring the light and praying to God the engine doesn't blow up."
The Federal Reserve policymakers are disregarding the Taylor Rule, Fitz-Gerald said, because they're convinced they need to keep printing money to stimulate the stubbornly weak U.S. economy.
Yet something doesn't seem to add up…
If the Taylor Rule is based on U.S. economic data, and the Federal Reserve uses U.S. economic data to set policy, why aren't they pointing in the same direction?