November 24, 2014 / 6:00 PM / 5 years ago

Mixed signals from U.S. economy confound Fed: paper

SAN FRANCISCO, Nov 24 (Reuters) - Conflicting signals from economic data are making it hard for the U.S. Federal Reserve to use a well-known rule of thumb to set monetary policy, according to a San Francisco Fed study published on Monday.

The so-called Taylor rule, named after its author Stanford University professor John Taylor, generates an estimate for the appropriate level of interest rates based on the rate of inflation and the level of economic slack.

For much of the time since the Great Recession, the Taylor rule suggested the Fed push the policy rate well below zero to bring the economy back to health; since negative interest rates are difficult to engineer, the Fed resorted to unconventional methods of policy easing including massive bond-buying programs.

The Fed wound down its latest bond-buying stimulus last month, but is not expected to begin to raise rates from their current near-zero levels until the middle of next year.

Lately, the Taylor rule has generated very different policy rates depending on which measure of economic slack is used, the authors of the Fed study show.

Using the gap between the economy’s potential rate of growth and its actual growth, the Taylor rule currently suggests a policy rate that’s about a half of a percentage point below zero, the paper shows.

But using the gap between the actual unemployment rate and the lowest unemployment rate the economy can withstand without generating inflation, the Taylor rule currently prescribes a policy rate of about 1.5 percent, the paper shows.

“Determining whether the economy is overheating or underperforming is critical for monetary policy,” Early Elias, Helen Irvin and Oscar Jorda, the authors of the paper, wrote. “Our analysis highlights the difficulties of using the Taylor rule as a practical guide to implementing monetary policy in real time.” (Reporting by Ann Saphir; Editing by Paul Simao)

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