In a speech this past Tuesday, Fed Chair Powell reinforced market expectations for an October 29 rate cut. Futures market participants were already attaching a 94% probability to such an outcome last week, and this probability increased further to 96% following the speech. Powell stated that little had changed since September, employment growth continues to soften, and the estimated risks around tariff-related inflation have lessened. He also noted that the Fed’s goal would be to continue to return the policy rate to a more neutral setting. The question is, what interest rate would be consistent with that neutral setting?
The reality is that neither the Fed nor any of us knows for certain, though there are guideposts that can provide some direction. The Taylor rule is one such guidepost, and it is used to assess where the current policy rate should be relative to both inflation and economic growth. In this Economics Weekly, Richard de Chazal discusses why the Fed may have been right to keep rates below the Taylor rule’s policy prescription for the last two decades, and why a structural change in the inflation regime means it may no longer have that luxury.