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Disentangling Permanent and Transitory Monetary Shocks with a Nonlinear Taylor Rule

Author

Listed:
  • Lafuente Juan Ángel

    (Department of Finance and Accounting and IEI, University Jaume I, Castelló, Spain)

  • Monfort Mercedes

    (Department of Economics and IEI, University Jaume I, Castelló, Spain)

  • Pérez Rafaela
  • Ruiz Jesús

    (Department of Economic Analysis and Quantitative Economics, University Complutense, Madrid, Spain)

Abstract

This article provides an estimation method to decompose monetary policy innovations into persistent and transitory components using the nonlinear Taylor rule proposed in Andolfatto, Hendry, and Moran (2008) [Are inflation expectations rational? Journal of Monetary Economics, 55, 406–422]. To use the Kalman filter as the optimal signal extraction technique, we use a convenient reformulation for the state equation by allowing expectations to play a significant role in explaining the future time evolution of monetary shocks. This alternative formulation allows us to perform the maximum likelihood estimation for all the parameters involved in the monetary policy as well as to recover conditional probabilities of regime change. Empirical evidence on the US monetary policy making is provided for the period covering 1986-Q1 to 2021-Q2. We compare our empirical estimates with those obtained based on the particle filter. While both procedures lead to similar quantitative and qualitative findings, our approach has much less computational cost.

Suggested Citation

  • Lafuente Juan Ángel & Monfort Mercedes & Pérez Rafaela & Ruiz Jesús, 2021. "Disentangling Permanent and Transitory Monetary Shocks with a Nonlinear Taylor Rule," Economics - The Open-Access, Open-Assessment Journal, De Gruyter, vol. 15(1), pages 150-162, January.
    • Handle: RePEc:bpj:econoa:v:15:y:2021:i:1:p:150-162:n:8
    DOI: 10.1515/econ-2021-0010
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    More about this item

    Keywords

    Taylor rule; monetary shocks; Kalman filter; particle filter;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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