do to increase the production of agricultural commodities, let alone pros-
pecting, finding, and mining gold. However, it takes almost no time at all to
print a lot of money. That has spelled a lot of trouble in the past, because
this conceptually means that the price of reference commodities (gold,
silver, rice, wheat, and others) will have to go up in paper money (dollars)
because there are more dollars in the system compared to the limited pro-
duction and supply of the commodities. That spells big trouble down the
road. That trouble is called inflation, as we saw in the 1960s and 1970s.
The Fed Fund Interest Rates Setting Regime
The Taylor Rule12,13,14,15 This section attempts to summarize how the U.S.
Federal Reserve Board decides on a suitable level for the Fed Fund interest
rates (the interest rate charged by banks to each other for overnight borrow-
ing to balance their books, which is set by the Fed). The Fed Fund rate is one
of the important tools used by the Fed to decide on interest rates, which set
the policy of money supply in order to influence U.S. monetary and eco-
nomic policy. It is important that RF bankers understand the foundations
upon which these decisions are made and the mechanical procedures
followed. This information reveals that the Fed Fund rate set by the Federal
Reserve is a tool by which the monetary authorities manage the money
supply; it is different from the usury or interest prohibited by the injunctions
of Judeo-Christian-Islamic Law, or Shari’aa.
Professor John Taylor of Stanford University in California formally in-
troduced the Taylor Rule in 1994 to model the process by which the Federal
Reserve System sets a suitable Fed Fund rate. He suggested that the two pri-
mary factors that drive the model are the gross domestic product (GDP) gap
and the inflation gap.
Intuitively, these two factors have economic bases. This policy rule
states that if the economy is growing beyond its potential, or if the inflation
rate is greater than the Fed’s assumed target of (say) 2 percent, the Fed will
increase the Fed Funds. Professor John Taylor argued that the Federal
Reserve Board can be viewed as setting the target for the Federal Fund rate
at a level that is close to, say, 2 to 2.5 percent, with a level corrector mecha-
nism. He recommended that two correctors are added. These are:
1.Aninflation corrector;calledtheinflation gap. It equals current infla-
tion rates minus the inflation rate targeted by the Fed.
2.Aneconomic growth corrector, called theoutput gap(GDP^16 correc-
tor), which is equal to current GDP minus potential GDP.He also suggested assuming a most likely scenario that the impact of
numbers 1 and 2 above is equally weighted, at 50 percent each. Another
Money and Its Creation 99