Six Rules Suggest The Fed Should Not Be Cutting Interest Rates

The Cleveland Fed projects interest rates based on various rules.

Please consider Simple Monetary Policy Rules by the Cleveland Fed.
March 6 Data

2026 Q2 Estimate

• Taylor (1993) rule: 3.89

• Core inflation in Taylor (1999) rule: 3.72

• Inertial rule: 3.84

• Alternative r* rule: 3.97

• Forward-looking rule: 3.68

• Low weight on output gap rule: 3.88

The article discusses seven rules, but I dropped the “First Difference Rule” because it blew the chart scale with a forecast over 12.53 percent for 2028 Q1.

12.5 percent seems. Let’s discuss the widely-followed Taylor Rule.

The Taylor Rule is an influential formula developed by economist John Taylor that has shaped monetary policy strategy by linking interest rates to inflation and economic growth targets.

Taylor Rule Components

r = p + 0.5y + 0.5(p – 2) + 2

• r : Nominal federal funds rate (target)

• p : Rate of inflation

• y: Output gap (percent deviation of actual GDP from potential GDP)

• 2: The target inflation rate (2%)

• 2: Assumed equilibrium real interest rate

The formula is nonsense because the output gap and equilibrium interest rates cannot be directly measured.

Second, inflation cannot be accurately measured. Even if inflation it could be accurately measured it’s a lagging indicator.

Third, there is no reason for the Fed to target 2 percent in the first place.

All of the rules have similar issues.

Question of the Day

Q: Can you steer the economy like a truck?
A: Of course not, and the Fed provides ample proof.

Q: How so?
A: By repeatedly blowing bubbles of increasing magnitude over time.

Moreover, the Fed uses asinine measures of inflation in all of its models.

For example, the Fed (economists in general) do not have the price of houses, the cost of homeowners insurance, property taxes, or money supply in their measures of inflation.

They view consumer inflation as the only measure that counts.

Former Fed Chair Ben Bernanke denied there was a housing bubble. He could not see the massive inflation because the Fed does not count housing prices as inflation.

In the real world, inflation matters, not just alleged consumer inflation.

Even if economists could accurately guess the output gap and equilibrium interest rate, the models are all flawed with bad measures of inflation.

When you start off with ridiculous measures of inflation, no model can get things right.

Conclusion

The Fed should not be using models because there should not be a Fed at all.

However, as bad as the Fed may be, politically set interest rates are guaranteed to be worse.

Only the free market has a chance of getting things right.

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