An Examination of a Modified Taylor Rule

Is there a rules-based explanation for the low interest rates and quantitative easing undertaken by the Federal Reserve following the Global Financial Crisis? The question is important as it pertains to the ongoing debate between rules-based and discretionary monetary policy. It is also important in the search for a Taylor Rule modification that can fill in the gap left by the breakdown of the original rule following the GFC. This paper examines a recent Taylor Rule modification proposed from James Bullard, President of the St. Louis Federal Reserve, to see if this modification can explain Fed actions following the GFC. The modification is analyzed in the same two ways that the original Taylor Rule was evaluated. Namely, this paper tests the economic logic of the modification as well as examines how well the rule's policy rate prescription has fit the actual federal funds rate over time. The economic logic of the modification is examined during recessions. The fit between the rule's policy rate prescription and the actual federal funds rate is examined using r-squared. I conclude that by changing the neutral rate in a Taylor-type rule, Bullard provides a credible policy rule that helps explain Fed behavior following the GFC.