Bloomberg News

Fed Economists Say Taylor Rule Shows Rates Should Vary by Region

February 27, 2012

A rule designed to help central bankers determine whether to change the main interest rate indicates that borrowing costs should vary across U.S. regions, the Federal Reserve Bank of San Francisco said.

“The same kinds of tensions over monetary policy that are found in a monetary union of many separate countries, such as the euro area, can appear in a single diverse country, such as the United States,” Israel Malkin and Fernanda Nechio at the San Francisco Fed wrote in a report released today. “These divergent regional Taylor rule policy rates stem from differences in unemployment and inflation rates across regions.”

Developed by Stanford University professor John Taylor, the Taylor rule is designed to determine the optimal interest rate based on inflation and output. The formula predicted at the end of 2011 policy rates ranging from 0.35 percent in the West to 3 percent in the Midwest, the report said.

The Fed has held the federal funds rate at zero to 0.25 percent since December 2008.

The divergence among four U.S. regions wasn’t as great as the variation between peripheral and core nations within the euro area. The Taylor rule would recommend a rate of minus 2 percent among peripheral countries and 5 percent among core nations in 2011, according to the regional bank economists.

“The relatively greater regional balance in the United States can be attributed to higher labor mobility, which permits greater responsiveness to unemployment,” Malkin and Nechio said. “By contrast, inside the euro area, cross-country labor movement is still very limited.”

To contact the reporter on this story: Aki Ito in San Francisco at aito16@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net


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