Each month I post an update to the equation to determine the Fed rate based on Effective Demand.
The rate rose from 3.1% to 3.3% in the month of September due to the drop in unemployment to 5.9% and the rise in capacity utilization to 79.3. Inflation held steady at 1.74%.
The Fed continues to be way behind the curve to normalize the Fed rate before the end of the business cycle hits. They are waiting for the recovery apparently.
Equation for ED rule...
ED target Fed rate = z*(TFUR2 + ELS2) – (1 – z)*(TFUR + ELS) + inflation target + 1.3*(current inflation – inflation target)
z = (2*ELS + NR)/(2*(ELS2 + ELS))
TFUR = Total Factor Utilization Rate, (capacity utilization * (1 – unemployment rate)).
ELS = Effective Labor Share is Non-farm Labor Share: Business sector * 0.765. Equation for ELS = (7.2*previous quarter ELS + 2.5*2 quarters previous ELS)/9.7
NR = Natural real rate of interest of 1.8% since crisis.
Inflation target = 2.0%
Current inflation = The monthly value of CPI (less food & energy).
1.3 coefficient = To give the Fed rate leverage when inflation gets off target. Fed rate would change 1.3x more than inflation is off target. Same value as used in the Rudebusch rule.