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Monetary policy deviations: A Bayesian state-space analysis

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  • Scott, C. Patrick
  • Barari, Mahua

Abstract

The following paper contributes to a growing body of literature examining the degree to which monetary policy deviates from a systematic rule. We extend an error correction model of the Fed's reaction function by Judd and Rudebusch (1998) by endogenizing the unobserved inflation target in a model that nests the constant target model as a special case. The model is iteratively updated using a Kalman filter and estimated using Bayesian methods. The draws from the posterior distribution are used to estimate a distribution of Taylor rules with which to compare observed policy and more appropriately estimate deviations. This approach more accurately represents the parameter space given our data. Estimates imply a significant deviation in Fed policy over the years preceding the housing market decline. Restricted model variations imply no evidence of strict inflation targeting, but strict output gap targeting behavior cannot be ruled out over the Burns and Volcker tenure.

Suggested Citation

  • Scott, C. Patrick & Barari, Mahua, 2017. "Monetary policy deviations: A Bayesian state-space analysis," The Quarterly Review of Economics and Finance, Elsevier, vol. 63(C), pages 1-12.
    • Handle: RePEc:eee:quaeco:v:63:y:2017:i:c:p:1-12
    DOI: 10.1016/j.qref.2016.04.015
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    References listed on IDEAS

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    1. Peter N. Ireland, 2007. "Changes in the Federal Reserve's Inflation Target: Causes and Consequences," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(8), pages 1851-1882, December.
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    3. Leigh, Daniel, 2008. "Estimating the Federal Reserve's implicit inflation target: A state space approach," Journal of Economic Dynamics and Control, Elsevier, vol. 32(6), pages 2013-2030, June.
    4. C. Patrick Scott, 2016. "Are central bank preferences asymmetric when policy targets vary over time?," Empirical Economics, Springer, vol. 51(2), pages 577-589, September.
    5. Maarten Dossche & Gerdie Everaert, 2005. "Measuring Inflation Persistence: A Structural Time Series Approach," Computing in Economics and Finance 2005 459, Society for Computational Economics.
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    11. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
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    Cited by:

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    2. Scott C. Patrick, 2020. "How Much Better Is Commitment Policy Than Discretionary Policy? Evidence From Six Developed Economies," The B.E. Journal of Macroeconomics, De Gruyter, vol. 20(2), pages 1-28, June.

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    More about this item

    Keywords

    Interest rate; Policy deviations; Taylor rule; Bayesian estimation; Time varying inflation target;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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