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Strategies & Market Trends : The Art of Investing
PICK 54.42+1.0%Jan 9 4:00 PM EST
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From: Sun Tzu6/27/2022 12:41:37 PM
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Recommended By
Jacob Snyder

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I was up till late last night looking into various Fed models. They are explained in the latest Fed report to the congress.

This is what I found out last night. The model that the Fed seems to be most comfortable with is a modified Taylor model with several important modifications:

(1) They set the neutral FFR at 1% above inflation
(2) They use PCE instead of CPI
(3) They use Employment instead of GDP - this make sense since the Fed's other mandate is employment which is correlated with GDP but why bother to use a proxy?
(4) The modified Taylor model acknowledges that interest rates cannot go below zero and therefore delays the return to neutral instead to compensate for when the interest rates should have gone negative.

Even with all this, the model is incomplete because it does not account for QE and QT. For now the Fed seems to have decided to set the rates on the First-Difference Rule and then decide what to do when it gets there. Powell was very clear that he uses the models simply as guides and then watches what happens in the real economy before deciding how to proceed. Seems like a wise approach to me.
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