Wednesday, December 16, 2009

Correspondence

I assume that you were sarcastic about the arbitrary numbers in the Taylor Rule, but can you explain why the log of GDP and potential GDP are used?

It's actually been a while, but log is almost always used in economics to linearize an exponential function because linear functions are easier to work with. I know GDP growth is exponential, which is to say that if the economy grows at 3% each year, then the formula for determining GDP X years from now is (GDP) multiplied by (1.03) to the X power. Taking the log turns GDP and potential GDP into linear functions.

That's my guess.

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