Taylor Rule

The Taylor rule is a formula that suggests where a central bank's policy rate should sit given inflation and the output gap: the rate rises when inflation runs above target and when the economy runs above capacity, and falls when either is below. It was proposed as a description of how central banks behaved, and it became a benchmark against which their decisions are judged. No major central bank follows it mechanically, and its output depends heavily on which estimates of the neutral rate and potential output are plugged in. Traders use it as a rough gauge of whether policy looks loose or tight relative to the data, not as a forecast of the next decision.