Taylor rule

Using a series of examples, we review various ways in which a monetary policy characterized by the Taylor rule can inject volatility into the economy. In the examples, the incorporation of an escape clause into the Taylor rule can reduce or even entirely eliminate the problems. Under the escape clause, the central bank monitors the money growth rate and commits to abandoning the Taylor rule in favor of a money growth rule in case money growth passes outside a particular monitoring range.

This paper examines the optimal monetary policy under discretion using a small macroeconomic model that allows for varying degrees of forward-looking behavior. We quantify how forward-looking behavior affects the optimal response to inflation and the output gap in the central bank's interest rate rule. Specifically, we isolate the influence of forwardlooking behavior in the aggregate demand equation, the wage contracting equation, and the term structure equation. We show that the data cannot uniquely identify the degree of forward-looking behavior in this class of models. Nevertheless, by imposing some assumptions about forward-looking behavior that are motivated by economic theory, we show that a plausible set of parameters can deliver the Taylor rule as the optimal monetary policy under discretion. We find that a successful parameter combination must include one or more of the following: (i) a high degree forward-looking behavior in the aggregate demand equation, (ii ) a low degree of forward looking-behavior in the term structure equation, or (iii) a large (but still plausible) interest rate sensitivity parameter in the aggregate demand equation.

Chile was the second country in the world to adopt inflation targeting (IT), setting its first annual target in September 1990. IT was used as a device to bring inflation gradually down to a stationary 3% level. This paper analyzes four main questions, exploiting Chile's long IT experience. Is Chile's experience different from that of other countries that have adopted IT during the 1990s? Has IT contributed to monetary policy credibility in Chile? Does the monetary authority exhibit fear of floating? Is the Central Bank's monetary policy function consistent with the goals of IT? The evidence reported in this paper shows that credibility grew as inflation targets were attained, that there is little "fear of floating," and that monetary policy has evolved according to the strengthening of IT and attainment of stationary inflation.

La nouvelle Zélande est le pays ayant la plus grande expérience en politique du ciblage d'inflation. Cette politique a été annoncée en 4 Mars 1989 et mise en oeuvre en 1 ér Février 1990. Ce pays admet une cible d'inflation bien définie et une structure politique claire mise en place pour la réussir. En effet, pour conduire une telle politique Taylor, a mis en place une règle nommée la règle de Taylor. Cette règle est devenue une référence pour la plupart des études qui cherchaient les règles et les instruments adéquats de la conduite des politiques économiques. Durant ce travail de recherche, nous allons montrer si cette règle avec les paramètres conventionnels déterminés sur l'économie des Etats-Unis décrit le comportement de la réserve banque de la nouvelle Zélande. Sachant que cette dernière accorde plus de préoccupation à la stabilité des prix qu'à la stabilité de l'activité économique. Ainsi, vu les différences dans les objectifs et dans les structures des différentes économies, la règle de Taylor diffère d'un pays à d'autres. Ceci conduit à l'émergence des règles des Types de Taylor. De ce fait, pour déterminer l'instrument qui répond mieux aux comportements de la banque centrale de la nouvelle Zélande, on adopte en premier lieu la méthodologie suivie par Clarida, Galí et Gertler (1998). À partir de là, on montre, dans une première étape, que la banque centrale de la nouvelle Zélande suit une règle de type de avec des données courantes d'inflation et d'output gap et elle adopte un ajustement partiel du taux d'intérêt. Cet ajustement de taux est d'adopter pour assurer une stabilité au sein de l'économie et évite d'opérer de trop fréquents retournements de son taux d'intérêt directeur afin de minimiser les coûts d'apprentissage. Or suite aux critiques adressées par certains auteurs tel que McCallum qui suggère que ce type de fonction n'est plus opérationnel étant donné qu'elle a besoin des informations que les décideurs de politiques ne disposent pas actuellement. Ainsi en utilisant la propre prévision de la BCNZ d'inflation, on conclue que la règle optimale de conduite de politique monétaire est celle avec prévision d'inflation (c'est-à-dire sous version Forward-Looking). En dernière étape, il s'agit de vérifier l'hypothèse si la BCNZ agit explicitement aux fluctuations du taux de change étant donné que cette variable inclue des informations additionnelles sur l'allure future de l'inflation qui n'est pas nécessairement capturée par l'inflation courante et/ou l'output gap. Le résultat nous amène à conclure que la BCNZ n'agit pas explicitement aux fluctuations du taux de change, mais selon les critères de sélection du modèle, cette variable doit être prise en compte dans la fonction de réaction de la banque centrale. Ceci est dû au canal de transmission indirect du canal du taux de change.

We develop a graphical 3-equation New Keynesian model for macroeconomic analysis to replace the traditional IS-LM-AS model. The new graphical IS-PC-MR model is a simple version of the one commonly used by central banks and captures the forward-looking thinking engaged in by the policy maker. Within a common framework, we compare our model to other monetary-rule based models that are used for teaching and policy analysis. We show that the differences among the models centre on whether the central bank optimizes and on the lag structure in the IS and Phillips curve equations. We highlight the analytical and pedagogical advantages of our preferred model. The model can be used to analyze the consequences of a wide range of macroeconomic shocks, to identify the structural determinants of the coefficients of a Taylor type interest rate rule, and to explain the origin and size of inflation bias.

In this paper, we propose a simple econometric framework to disentangle the respective roles of monetary policy inertia and persistent shocks in interest rate rules. We exploit the restrictions of a DSGE model that is confronted with a monetary SVAR. We show that, provided enough informative variables are included in the formal test, the data favor a monetary policy representation with modest inertia and highly serially correlated monetary shocks. To the contrary, when the procedure is based solely on the dynamic behavior of the nominal interest rate, no clear-cut conclusion can be reached about the correct representation of monetary policy.

This paper performs a welfare analysis based on the hypothetical scenario that Denmark gave up its peg and started conducting monetary policy according to a Taylor rule. For this we rely on a dynamic stochastic general equilibrium model for a small open economy that was estimated on Danish data using Bayesian methods. We obtain the result that the gain in welfare is equivalent to a permanent increase of around 0.8 pct in the level of consumption. Examining a range of alternative scenarios does not change this conclusion, unless we assume a degree of policy errors under the Taylor rule that is substantially larger than those estimated by other studies.

This paper studies the performance of monetary policy under alternative fiscal regimes in a dynamic New Keynesian optimizing general equilibrium model with wealth effects. The interactions between fiscal policy and interest rate rules are shown to have relevant implications for the existence of a unique rational expectations equilibrium. When calibrated to Euro Area quarterly data, the model simulation results show

Based on Plasmans et al. (2006), we develop a microfounded macro New-Keynesian model for open economies, be them large or small, and we investigate the exchange rate pass-through to import prices in the context of a monetary policy. More specifically, we study two different versions of a Taylor rule (without and with interest rate smoothing), each in contemporaneous, backward-looking and

This article offers a deconstructive analysis of the alternative benchmarking conceptualization with reference to Taylor's rule. The conceptual note which is the subject of the article is based on the idea that the Taylor equation is based on two variables: inflation and production. However, the rule has a third variable: the real interest rate. Giving a fixed value to a variable does not mean its cancellation, just as giving a zero value to the interest rate does not mean its cancellation. Even if this assumption was not considered, it should be noted that the driving force behind the mainstream growth model is the banking credit based on ex nihilo money creation. The analysis of quantitative models should not be limited to the exploration of the relationship between variables, it must first identify the epistemological presuppositions, i.e. fundamentally the underlying worldviews.

In this paper we analyze whether the current macroeconomic environment in India is suitable for implementation of inflation targeting as a monetary policy strategy, in light of the recommendation of the Urjit Patel Committee Report. Our results indicate that historically the Reserve Bank of India has given more importance to inflation compared to output growth and exchange rate changes in its monetary policy conduct and that in recent times there has been an increased emphasis on monetary independence thereby comfortably placing the RBI on a path to move towards inflation targeting. However we also find factors, that are traditionally outside the control of monetary policy, do exert a strong impact on aggregate prices in India thereby making the choice of nominal anchor a tricky one. Furthermore, the success of monetary policy in containing inflation is found to be crucially contingent on an appropriate fiscal policy as well.

This paper examines the Taylor rule in the context of United States monetary policy since 1965, particularly with respect to the zero-lower-bound era of the federal funds rate from 2009 to 2016. A nonlinear Taylor rule is developed which features smooth transitions in the first two moments of the federal funds rate. This flexible specification is found to usefully capture observed nonlinearity, while accounting for the well-documented structural changes in monetary policy formation at the Federal Reserve in the last fifty years, and especially in the recent zero-lower-bound era.

The interbank market helps regulate liquidity in the banking sector. Banks with outstanding resources usually lend to banks that are in needs of liquidity. Regulating the interbank market may actually benefit the policy stance of monetary policy. Introducing an interbank market in a general equilibrium model may allow better identification of the final effects of non-conventional policy tools such as reserve requirements. We introduce an interbank market in which there are two types of private banks and a central bank that has the ability to issue money into a DSGE model. Then, we use the model to analyse the effects of changes to reserve requirements (a macroprudential tool), while the central bank follows a Taylor rule to set the policy interest rate. We find that changes to reserve requirements have similar effects to interest rate hikes and that both monetary policy tools can be used jointly in order to avoid big swings in the policy rate (that could have an undesired effect on private expectations) or a zero bound (i.e. liquidity trap scenarios).

This paper investigates the monetary policy reaction functions of the Central Bank of Republic of Turkey (CBRT) over the periods 1987: 01-2001:12 and 2002:01-2009:05. We specifically attempt to shed light on question to what extent exchange rate developments still continue to influence monetary policy, even under inflation targeting. This study seeks to investigate how the monetary policy responded to the exchange rate shocks before and after adoption of inflation targeting regime. How large the effect of exchange rate shocks is accounted for in forecast error variances decompositions for monetary policy as compared to other shocks? Using the VAR model, this study shows that there has been strong pass-through during whole period. Moreover, in the postcrisis period, exchange rate has been the main reaction variable for the CBRT.

We analyze the efiects of flscal policy in a currency area. We de- velop a two-region model having sticky prices, a common monetary authority and regional flscal policies. We break the ricardian equiva- lence and allow for keynesian efiects of public expenditure introducing rule-of-thumb agents in each region. Main results are the following. First, consistently with the empirical evidence, after a public spend- ing shock in one region private agents demand for imports increases and the terms of trade appreciates. Second, a countercyclical flscal rule can restore the Taylor principle and the uniqueness of the equi- librium. Finally, a countercyclical flscal rule contributes to reduce macroeconomic volatility.

This paper characterises rules-based fiscal policy setting. Basically, we translate a standard monetary policy rule into a simple fiscal policy rule. We then infer on fiscal policymakers' reaction coefficients by testing the rule with GMM. Interaction is also tested directly by the inclusion of monetary policy setting. Our results qualify existing evidence on systematic fiscal policy in two respects. First, fiscal policy usually stabilises public debt. And there is indeed substantial interaction between fiscal and monetary policy via the debt channel. Second, sustainability is achieved with a "stop-go" cycle of consolidation. Consolidation does not come at the cost of less cyclical stabilisation unless debt ratios are high.

The zero lower bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. We use the FRB US model to quantify the e ects of the bound on macroeconomic stabilization and to explore how policy can be designed to minimize these e ects. During particularly severe contractions, open-market operations alone may be insu cient to restore equilibrium; some other stimulus is needed. Abstracting from such rare events, if policy follows the Taylor rule and targets a zero in ation rate, there is a signi cant increase in the variability of output but not in ation. However, a simple modi cation to the Taylor rule yields a dramatic reduction in the detrimental e ects of the zero bound.

The interbank market helps regulate liquidity in the banking sector. Banks with outstanding resources usually lend to banks that are in needs of liquidity. Regulating the interbank market may actually benefit the policy stance of monetary policy. Introducing an interbank market in a general equilibrium model may allow better identification of the final effects of non-conventional policy tools such as reserve requirements. We introduce an interbank market in which there are two types of private banks and a central bank that has the ability to issue money into a DSGE model. Then, we use the model to analyse the effects of changes to reserve requirements (a macroprudential tool), while the central bank follows a Taylor rule to set the policy interest rate. We find that changes to reserve requirements have similar effects to interest rate hikes and that both monetary policy tools can be used jointly in order to avoid big swings in the policy rate (that could have an undesired effect on private expectations) or a zero bound (i.e. liquidity trap scenarios).

The aim of the present research is to use a model economy built for Brazil, based on an optimizing dynamic general equilibrium model, in order to perform numerical simulations to derive the ability of the artificial economy to explain the impact of monetary policy interventions on Brazilian short run economic performance in terms of the inflation rate, output gap, interest

We analyze the effects of fiscal policy in a currency area. We develop a two-region model having sticky prices, a common monetary authority and regional fiscal policies. We break the ricardian equivalence and allow for keynesian effects of public expenditure introducing rule-of-thumb agents in each region. Main results are the following. First, consistently with the empirical evidence, after a public spending shock in one region private agents demand for imports increases and the terms of trade appreciates. Second, a countercyclical fiscal rule can restore the Taylor principle and the uniqueness of the equilibrium. Finally, a countercyclical fiscal rule contributes to reduce macroeconomic volatility.

We estimate rules and identify monetary policy shocks using no-arbitrage pricing techniques. Long-term interest rates are risk-adjusted expected values of future short rates and thus provide strong over-identifying restrictions about the policy rule used by the Federal Reserve. The no-arbitrage framework also accommodates backward-looking and forward-looking Taylor rules. We find that inflation and output gap account for over half of the variation of time-varying excess bond returns and most of the movements in the term spread. Taylor rules estimated with no-arbitrage restrictions differ from Taylor rules estimated by OLS, and the resulting monetary policy shocks are somewhat less volatile than their OLS counterparts.

We compare the transmission mechanism of exogenous and endogenous monetary policies in a calibrated small open economy model with nominal and real rigidities. Under an exogenous monetary policy rule it takes implausible values of the intertemporal elasticity of substitution and the price adjustment costs to generate the liquidity and overshooting effects. Endogenous rules with strong feedback to inflation and output help to reproduce the response of the nominal interest and exchange rates to unanticipated monetary policy shocks that characterize the transmission mechanism of standard sticky price models. The liquidty and overshooting effects are always obtained when the model is augmented with a Taylor interest rate rule.

The paper studies the role of income distribution within a medium-scale macrodynamic model built in a Keynesian and Goodwinian tradition. Combining a wage and price Phillips curve, adjustments of an inflation climate, an IS relationship determining output, Okun's law for employment and the Taylor rule for monetary policy, a semi-structural model is obtained that incorporates the most important macroeconomic channels in a closed economy. After assessing the reasonable time series variabilities in stochastic simulations, a deeper analysis is concerned with the stabilizing and destabilizing effects of the model's parameters, and with a structural shift in income distribution. In many details of these investigations, the distinction between a wage-led and profit-led regime becomes important.

In this paper we formulate a disequilibrium AS-AD model based on sticky wages and prices, perfect foresight of current inflation rates and adaptive expectations concerning the inflation climate in which the economy operates. The model consists of a wage and a price Phillips curves, a dynamic IS curve as well as a dynamic employment adjustment equation and a Taylor-rule-type interest rate law of motion. Through instrumental variables GMM system estimation with aggregate time series data for the U.S. and the Eurozone economies, we obtain structural parameter estimates which support the specification of our theoretical model and show the importance of the inflationary climate, as well as of the Blanchard-Katz error correction terms, and indirectly of income distribution, in the dynamics of wage and price inflation in the U.S. and the Eurozone economies.

Over the past twenty years, the federal funds rate has evolved from being an intermediate target or indicator variable in discussions of monetary policy to the Federal Reserve’s (exogenous) policy instrument. How the funds rate is characterized has important implications for modeling, particularly in settings such as the popular Taylor Rule. Crucially, however, little investigation has been done to examine whether the funds rate meets the conditions one would require for an instrument of policy. This paper offers empirical evidence on the relationships among the federal funds rate, variables that might influence its behavior and variables of interest to monetary policy.

We conduct a thorough statistical analysis of the empirical foundations for the existence of a Taylor rule. Inflation, the output gap and the federal funds rate appear to be non-stationary variables that are not cointegrated. Although this lack of cointegration could be caused by missing variables or structural breaks, we are unable to 'salvage' the rule using several plausible candidate variables and break dates. We also investigate the possibility that the Taylor rule should be modeled as a nonlinear relationship. We find that a simple threshold model makes significant progress towards rectifying some of the shortcomings of the standard model.

The preliminary results suggest that the introduction of habit persistence into the consumption hypothesis does not make much difference. However the introduction of different monetary reaction functions does alter the impulse response of output, inflation ...

We estimate several variants of a linearized form of a New Keynesian model using quarterly US data. Using these rival models and the estimated posterior probabilities we then design rules that are robust in two senses: 'weakly robust' rules are guaranteed to be stable and determinate in all the possible variants of the model, whereas 'strongly robust' rules, in addition, use the probabilities to minimize an expected loss function of the central bank subject to this model uncertainty. We find three main results.

This paper studies the performance of monetary policy under alternative fiscal regimes in a dynamic New Keynesian optimizing general equilibrium model with wealth effects. The interactions between fiscal policy and interest rate rules are shown to have relevant implications for the existence of a unique rational expectations equilibrium. When calibrated to Euro Area quarterly data, the model simulation results show that the preferred monetary-fiscal regime for inflation stabilization consists of a generalized Taylor rule with a low degree of inertia coupled with a public debt-GDP ratio targeting rule.

In this paper we jointly evaluate the Federal Reserve staff forecasts of U.S. real output growth and the inflation rate assuming the forecasts are to be used as inputs for the Taylor rule. Our simple methodology generates "policy forecast errors" which have a direct interpretation for the impact of forecast errors on the target interest rate given by the Taylor rule. Without interest rate smoothing, we find that, on average, the Taylor rule target interest rate would have been approximately a full percentage point away from the intended target because of errors in forecasting output growth and inflation. Our results are robust to changes in the forecast horizon and to changes in the weights on the variables in the policy rule. 1 Corresponding author. Phone: 202-994-7988. Fax: 202-994-6147. The authors wish to thank

This study demonstrates the relationship between exchange rate determination and an endogenous monetary policy represented by Taylor rules. We fill a gap in the literature by focusing on a group of fifteen emerging economies that adopted free-floating exchange rates and inflation targeting beginning in the mid-1990s. Because of the limited span of the time series, which is a common obstacle to studying emerging economies, we employ panel data regressions to produce more efficient estimates. Following the recent literature, we use a robust set of out-of-sample statistics, incorporating bootstrapped and asymptotic distributions for the Diebold-Mariano statistic, the Clark and West statistic and Theil's U ratio. By evaluating different specifications for the Taylor rule exchange rate model based on their out-of-sample performances, we find that a present-value forward-looking specification shows strong evidence of exchange rate predictability. 3 Kingdom, Japan and Germany, these authors concluded that, with a one-to twelve-month forecasting horizon, the random walk model performs at least as well as the exchange rate models of that time (i.e., the flexible price and sticky price monetary models and a hybrid model by ).

This paper provides a characterization of monetary policy in the euro area and a discussion of the manner in which the European Central Bank (ECB) conducts and implements it. More precisely, we examine the conduct of monetary policy as implemented by the ECB using two distinct but closely related approaches, which rely on the assumption that monetary policy can be usefully characterized in terms of a simple Taylor-type reaction function. First, the ECB policy is assessed against the benchmark of the Bundesbank's reaction function and second we impose ad-hoc Taylor rules. The policymaker's perception about the equilibrium real interest rate is important. Our analysis suggests that such perceptions may have changed over the period of the ECB's short life.

In the model, the persistence parameter of the real exchange rate is closely related to the measure of price stickiness in the Calvo-pricing model. When we employ this view, 3 to 5 year consensus half-life implies that firms update their prices every 18 to 30 quarters on average. This is at odds with most estimates from U.S. aggregate data when single equation methods are applied to the New Keynesian Phillips Curve (NKPC), or when system methods are applied to Dynamic Stochastic General Equilibrium (DSGE) models that include the NKPC. It is well known, however, that there is a large degree of uncertainty around the consensus half-life of the real exchange rate. To obtain a more efficient estimator, this paper develops a system method that combines the Taylor rule and a standard exchange rate model to estimate half-lives. We use a median unbiased estimator for the system method with nonparametric bootstrap confidence intervals, and compare the results with those from the single equation method typically used in the literature. Applying the method to the real exchange rates of 18 developed countries against the U.S. dollar, we find that most of the half-life estimates from the single equation method fall in the range of 3 to 5 years with wide confidence intervals that extend to positive infinity. In contrast, the system method yields median-unbiased estimates that are typically shorter than one year with much sharper 95% confidence intervals, most of which range from 3 quarters to 5 years. These median unbiased estimates and the lower bound of the confidence intervals for the half-lives of real exchange rates are consistent with most estimates of price stickiness using aggregate U.S. data for the NKPC and DSGE models.

We introduce endogenous growth in an otherwise standard NK model with staggered prices and wages. Some results follow: (i) monetary volatility negatively affects long-run growth; (ii) the relation between nominal volatility and growth depends on the persistence of the nominal shocks and on the Taylor rule considered; (iii) a Taylor rule with smoothing increases the negative effect of nominal volatility on mean growth.

In this paper I add to the evidence on possible nonlinearities in the conduct of ECB monetary policy. For this purpose a nonlinear Taylor rule (threshold regression) was estimated and compared to a linear benchmark model. The estimation was carried out with output gap data computed from quarterly GDP time series. The results show that a nonlinear Taylor rule fits the data better than a linear one.

T Ta ay yl lo or r--t ty yp pe e r ru ul le es s v ve er rs su us s o op pt ti im ma al l p po ol li ic cy y i in n a a M Ma ar rk ko ov v--s sw wi it tc ch hi in ng g e ec co on no om my y" " Abstract We analyse the effect of uncertainty concerning the state and the nature of asset price movements on the optimal monetary policy response. Uncertainty is modelled by adding Markov-switching shocks to a DSGE model with capital accumulation. In our analysis we consider both Taylor-type rules and optimal policy. Taylor rules have been shown to provide a good description of US monetary policy. Deviations from its implied interest rates have been associated with risks of financial disruptions.

We analyse the effect of uncertainty concerning the state and the nature of asset price movements on the optimal monetary policy response. Uncertainty is modeled by adding Markov-switching shocks to a DSGE model with capital accumulation. In our analysis we consider both Taylor-type rules and optimal policy. Taylor rules have been shown to provide a good description of US monetary

In a variety of recent papers, researchers have found that interest rate behaviour approximately follows a Taylor rule. We show that such interest rate behaviour results when the central bank may be following quite different monetary policy rules from the one ...