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Taylor Rules and Liquidity in Financial Markets

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  • Emanuele Franceschi

Abstract

We revisit the US monetary policy history in the framework of a Taylor rule, using real-time data and market information. We find significant instability in the parameters of the Federal Reserve Bank reaction function to output gap and expected inflation. Motivated by the global financial crisis and the growing attention to financial markets, we study the role of liquidity in the interest rate rule. We estimate Markov switching models and find compliance to the Taylor principle during the high inflation period for a standard Taylor rule and consistent violations of the Taylor principle once we include proxies for liquidity. Such violations are not associated to periods of unanchored inflation. JEL Codes: E31, E44, E58.

Suggested Citation

  • Emanuele Franceschi, 2021. "Taylor Rules and Liquidity in Financial Markets," Revue économique, Presses de Sciences-Po, vol. 72(1), pages 103-134.
    • Handle: RePEc:cai:recosp:reco_721_0103
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    1. Blampied, Nicolas & Cafferata, Alessia & Tibiletti, Luisa & Uberti, Mariacristina, 2024. "Optimal Monetary Policy and Taylor Rule Extensions," MPRA Paper 119923, University Library of Munich, Germany.

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    More about this item

    Keywords

    monetary policy rules; financial liquidity; Markov switching models; real-time data;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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