interest rates quite quickly, there can be a significant lag before those changes influence spending and saving decisions, in turn having an impact on overall output. Taylor rule Taylor has a study on the interest rate channel, and he shows that there is strong empirical evidence for significant interest rate effects on consumer expenditure and investments, making the interest-rate monetary transmission mechanism strong. The Taylor Rule describes the central bank interest rate as a function of inflation, and a measure of economic activity. More precisely, the target federal funds rate equals the long term real interest rate, plus the current inflation rate, plus coefficients multiplied by the deviations between real and target inflation and the deviations between real and potential output. This rule can serve as a device for policy decisions when the goal of the central bank is to achieve price stability. For example, when the inflation rate exceeds its target, the rule recommends an increase in the interest rate. Criticisms Despite the Taylor rule, some researchers, Bernanke and Gertler for example, had difficulty in their empirical studies identifying significant effects of interest rate through the costs of capital. Another issue economists have is with the assumption that monetary policy has its strongest influence on short-term interest rates, such as the federal funds rate. Since this rate is an overnight rate, monetary policy has a relatively weaker impact on the real long-term rate and hence on the purchases of durable assets. Finally, this mechanism neglects the credit business of the banking system. This shortcoming provided the stimulus for other transmission mechanisms of monetary policy, especially the credit channel. This channel should not be seen as a separate, free-standing alternative to the interest rate mechanism, but rather as a set of factors that strengthen and transmit the interest rate effects. See also Credit channel Quantity theory Monetary policy References Interest rates