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The rule may also apply the money supply and exchange rates as additional variables.
The Fed set the level of its monetary policy, the federal funds rate of 1987-1992, according to the two following assumptions: 1) if inflation crosses the 2 percent level, the Fed will increase the target federal funds rate to restrain inflation; 2) if income is below its potential level, the Fed will reduce the target interest rate to stimulate economic growth...
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Thus, the rule may help determine how far the real income of the economy is from its potential level.
Taylor showed that if the officials had used this equation in the 1970s, the macro indicators of the US economy would have been better than they were in reality. Inflation would not have passed out of control because the Fed would have been responsible for each rise in inflation...
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