Nowcasting and the Taylor Rule

Actual federal funds rates in the U.S. have, at times, deviated from the recommendations of a simple Taylor rule. This paper proposes a “nowcasting” Taylor rule that preserves the form of the Taylor rule but encompasses realistic assumptions on information observable to policymakers. Because contemporaneous inflation rates and output gaps are not observable at the time policy is set, policymakers must form “nowcasts.” The optimal nowcast will depend, in part, on forecast uncertainty whenever policymakers’ have asymmetric costs to overand under-predicting inflation and output. This paper estimates nowcasts and forecast uncertainty from the probability forecasts in the Survey of Professional Forecasters. Empirical evidence shows that actual policy rates are consistent with those recommended by a nowcasting Taylor rule. JEL Classifications: G12; G14; D82; D83