Taylor rule holds that the federal funds rate should be equal to the inflation rate plus 1? Equilibrium? The actual federal funds rate (the actual federal funds rate is the rate consistent with long-term full employment) plus the weighted average of two differences:

(1) inflation gap, that is, the current inflation rate minus the target inflation rate;

(2) Output gap, that is, the percentage deviation between actual GDP and estimated GDP under the potential full employment level. This rule can be written in the following form:

Federal funds rate index = inflation rate+balanced real federal funds rate.

+1/2 (inflation gap)+1/2 (output gap)

Taylor assumes that the equilibrium real federal funds rate is 2%, the appropriate target inflation rate is 2%, and the weight of inflation gap and output gap is 1/2.