The model features households and businesses that make decisions about spending and saving based on their expectations for the future and within their respective budget constraints. The model also includes a labor market where workers and employers search for each other to try to find matches — which lets us model the unemployment rate. Monetary policy is conducted according to a Taylor-type rule: The nominal interest rate smoothly adjusts in response to how far inflation deviates from its target and in response to economic activity.
Our baseline rule assumes that the monetary authority reacts to inflation and to the state of the economy as measured by the growth rate of output. We benchmark the projections implied by the model under this baseline rule against the projections implied by the model under alternative rules that put different weights on inflation and that react to the output gap (a measure of economic slack) instead of reacting to output growth as in the baseline. The alternative rules also feature different degrees of gradualism in interest rate decisions. When comparing the outcomes implied by each of these rules, we start from the same set of current conditions.
Because we are using a structural model, the rule in place and the actions of firms and households influence each other. For example, if a model predicts inflation above target and the economy operating above its potential, people and businesses understand that, other things constant, interest rates will increase, and they will adjust their investment and savings decisions accordingly.
This tool helps users see how the economy might evolve under different monetary policy rules using the Philadelphia Fed’s model. It shows how different rules, current conditions, and future outcomes interact.
Real-world policy might differ for reasons not included in our model. The implied policy path and forecasts displayed here do not necessarily reflect those of the Federal Reserve Bank of Philadelphia or the Federal Reserve System.
