Thursday, May 7, 2009

Taylor's Rule

The following article referring to Taylor’s Rule, was authored by FNB Chief Economist, Cees Bruggemans:

"Taylor's Rule*

Estimating where interest rates should be.

According to Taylor's Rule, the Prime Interest Rates should currently be :

"Neutral" Real Prime Rate 5.5%
(Average September 1989 - July 1995, 1999 - 2007)

Expected CPI inflation: 4Q 2010 5.0%

0.5 x (Current CPI - CPI "target") 2.0%
= 0.5 x (8.5% - 4.5%)

0.5 x (output "Gap") - 2.0%

Target Prime Interest Rate: 10.5%
Current Prime Interest Rate: 4 May 2009 12.0%

Comment: With the prime interest rate still lingering at 12%, the SARB is currently only 1.5% behind what a rough Taylor estimate suggests should be the interest rate level TODAY.

Financial markets today are discounting even lower rates later on this year, which isn’t unrealistic according to Taylor if the actual CPI inflation rate drops below 6% and the other 2010 assumptions about inflation and the output gap continue to apply.

But it will be up to the SARB to make the final call on the risks facing us, especially external financial ones and cost push domestic want."

Greg Beykirch
Financial Manager


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