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?
About the Author
David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.
Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.
Dave has a BA in English and Mass Communications from Loyola University Maryland.
IDIOT LIGHTS ARE FOR IDIOTS
Heard it all before. Been living the high life on too much debt and bad economics for years. Yep, "it won't end well". Markets driven more by "liquidity" not fundamentals. So what. Nobody really cares enough to do much about it, including the American People. Commentators still debating if we have a stock market bubble or not at P/E of 15 for the S&P 500 Index. Some blue chip dividend paying stocks have P/E's in their 20's. The question comes up: " Is this a stock market "bubble" (yet)?. The answer seems to be no, for now.
Dare we use the word addiction?It certainly popped into my head…
So what happens when this reckoning occurs ? Will it happen eventually based on a trigger outside the feds control, and what will that trigger be (or simply fed taper) ? Isn't that the important analysis ? How to plan aside from doom and gloom and a bunker in Montana ?