Monetary Rules Report
December 9, 2025
Summary
Federal Funds Rate Target Range: 3.75 - 4.00%
Expected Target Range after Dec. 10 FOMC: 3.50 - 3.75%
Rule-Implied Range: 3.66 - 4.24%
The Federal Open Market Committee (FOMC) is expected to lower its federal funds rate target by 25 basis points, to a range of 3.50 - 3.75%, at this week’s meeting. The expected decision is consistent with a nominal gross domestic product (NGDP) level rule, which prescribes a 3.66% target. The original Taylor rule prescribes a target of 3.93%, consistent with maintaining the current target range. A modified Taylor rule (4.16%) and NGDP growth rule (4.09%) prescribe slightly higher policy rates, as noted parenthetically.
An unusual degree of disagreement is expected at this week’s meeting. A majority of officials have argued that labor market weakness remains the most prominent risk. A substantial minority, however, have signaled greater concern with inflation remaining above the Fed’s 2% target. The leading monetary policy rules are roughly consistent with the expected 25 basis point cut, but suggest that debate within the FOMC is warranted. Slower growth, higher unemployment, or lower inflation is needed to justify additional easing in 2026.
Background
A monetary policy rule is a systematic guideline central banks can use to determine the appropriate stance of monetary policy. The most popular example, called the Taylor rule, instructs the central bank to set its federal funds rate target based on the prevailing rate of inflation and real economic activity. A nominal gross domestic product (NGDP) targeting rule, in contrast, suggests that the central bank should aim to stabilize nominal spending.
Taylor Rules
In his original formulation, Stanford economist John Taylor proposed that the federal funds rate target be set equal to a long-run neutral rate and adjusted as inflation deviates from the central bank’s target or real economic activity deviates from the economy’s full-employment potential. When inflation is above target or real economic activity exceeds potential, the central bank should raise its target rate. When inflation is below target or real economic activity falls short of potential, the central bank should lower its target rate. More formally, the original Taylor rule is written as follows:
where ft is the federal funds rate target, rt* is the real long-run neutral interest rate, πt* is the central bank’s inflation target, πt is the prevailing rate of inflation, and γt is a measure of the deviation in real economic activity from potential (.e.g., the unemployment gap).
Following Taylor’s original formulation, economists have proposed many other Taylor-type rules. For example, some make the rule “forward-looking” by including forecasts of expected future inflation rather than the most recently available historical data. The forward-looking Taylor rule is justified on the grounds that monetary policy often needs to act preemptively in anticipation of future developments, particularly with regard to stabilizing inflation expectations.
Another approach is to smooth the rule by including the weighted value of the most recent federal funds rate on the right-hand side of the formula. The smoothed Taylor rule is justified on the grounds that excessive interest rate volatility increases uncertainty and potentially destabilizes the link between short-term and long-term interest rates.
The modified Taylor rule presented above is both smoothed and forward-looking.
NGDP Rules
Some economists have developed Taylor-type rules that will stabilize nominal spending—or, nominal gross domestic product (NGDP). These rules advise the central bank to raise its policy rate when nominal spending growth is too high and lower its policy rate when nominal spending growth is too low. More formally, an NGDP targeting rule is written as follows:
where ft is the federal funds rate target, ρ is a smoothing parameter between 0 and 1, (rt* + πt*) is the nominal neutral interest rate, Ω is an adjustment parameter, and Nt is the nominal spending gap.
The nominal spending gap can take various forms. One option is to use the difference between the most recent NGDP growth rate and a 4% target growth rate, which is consistent with the idea that real GDP growth is typically around 2% and the Federal Reserve targets 2% inflation. Another option is to use the nominal spending gap, which measures the difference between actual nominal spending and expected nominal spending. The first option targets a growth rate for nominal spending, which does not account for previous deviations from target. The second option targets the level of nominal spending, which advises the central bank to make up for recent mistakes.
Estimates
Estimates for the original, smoothed, forward-looking, and modified (i.e., smoothed and forward-looking) Taylor rules are presented in Table 1. Two estimates are constructed for each rule. The first estimate uses the median projected longer run federal funds rate in the most recent Summary of Economic Projections as a proxy for the nominal neutral rate of interest, rt* + πt*. The second estimate uses the New York Fed’s Holston-Laubach-Williams estimate for the real interest rate, rt*.
Estimates for the NGDP growth and level rules are presented in Table 2. As with the Taylor rules presented above, I construct two estimates for each rule using the Summary of Economic Projections and New York Fed’s Holston-Laubach-Williams estimate. I employ a smoothing parameter equal to 0.5 and an adjustment parameter equal to 1.0 for all four estimates.
References
Beckworth, D., & Hendrickson, J. R. (2020). Nominal GDP targeting and the Taylor rule on an even playing field. Journal of Money, Credit and Banking, 52(1), 269-286.
Beckworth, D., & Horan, P. J. (2024). A two-for-one deal: Targeting nominal GDP to create a supply-shock robust inflation target. Journal of Policy Modeling, 46(6), 1071-1089.
Beckworth, D., & Horan, P. J. (2025). The fate of FAIT: salvaging the Fed’s framework. Southern Economic Journal, 91(4), 1391-1403.
Hendrickson, J. R. (2012). An overhaul of Federal Reserve doctrine: nominal income and the Great Moderation. Journal of Macroeconomics, 34(2), 304-317.
Luther, W. J. (2024). Neutral Nominal Spending and the Nominal Spending Gap. Sound Money Project Working Paper.
Taylor, J. B. (1993). Discretion versus policy rules in practice. In Carnegie-Rochester conference series on public policy (Vol. 39, pp. 195-214). North-Holland.