Is the U.S. Fed Fund Rate Too High or Too Low?

Is the U.S. Fed fund rate too high or too low? The Taylor Rule is the standard rule of thumb. With the original values, given the economy, the Fed Fund should be negative 2.25%! The screen shot below reflects the original values given by Taylor to the different coefficients. We can still his estimate (shown in blue) is pretty close to the historical values (in white).

According to Goldman Sachs (cited here), this implies that “Since the Fed can’t lower rates to less than zero, the Taylor rule means the central bank has to pump money into the economy through other methods, such as purchases of Treasuries, mortgage securities and agency bonds.”

Using better coefficient values (i.e., so that back-testing shows lower error; alpha and beta = 0.30), the Fed Fun rate would not increase before September 2010. Interestingly, that’s about what Eurodollar futures also imply -- see this older dataforthoughts post.