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Taylor Rules in the Quarterly Projection Model

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  • Jamie Armour
  • Ben Fung
  • Dinah Maclean
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    Abstract

    In recent years, there has been a lot of interest in Taylor-type rules. Evidence in the literature suggests that Taylor-type rules are optimal in a number of models and are fairly robust across different models. The reaction function in the Bank of Canada's Quarterly Projection Model (QPM) is an inflation-forecast-based (IFB) rule. A number of studies have suggested, however, that the optimality of IFB rules is very model-specific. Given this and concerns about model uncertainty, it seems logical to assess the performance of Taylor-type reaction functions in QPM. Therefore, we compare QPM's IFB rule with a simple Taylor rule as well as with two rules that include open-economy elements. Overall, our results suggest that Taylor-type rules do not perform well in QPM compared with the base-case IFB rule, since they are associated with significantly higher variabilities of inflation, output, and interest rates. However, of the Taylor-type rules considered, we find that a simple rule with a coefficient of 2 on the contemporaneous inflation gap (versus 0.5 in Taylor's original rule) and a coefficient of 0.5 on the output gap is the most appropriate. Furthermore, the gains from using open-economy rules seem to be limited.

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    Bibliographic Info

    Paper provided by Bank of Canada in its series Working Papers with number 02-1.

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    Length: 48 pages
    Date of creation: 2002
    Date of revision:
    Handle: RePEc:bca:bocawp:02-1

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    Related research

    Keywords: Monetary policy framework; Uncertainty and monetary policy; Economic models;

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    References

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    1. Frank Smets, 1998. "Output gap uncertainty: does it matter for the Taylor rule?," BIS Working Papers 60, Bank for International Settlements.
    2. Amano, Robert & Coletti, Don & Macklem, Tiff, 1999. "Monetary Rules When Economic Behaviour Changes," Working Papers 99-8, Bank of Canada.
    3. Andrew Levin & Volker Wieland & John C. Williams, 1998. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Working Papers 6570, National Bureau of Economic Research, Inc.
    4. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
    5. P Clark & D Laxton, 1997. "Phillips Curves," CEP Discussion Papers dp0344, Centre for Economic Performance, LSE.
    6. Svensson, Lars E O, 1999. " Inflation Targeting: Some Extensions," Scandinavian Journal of Economics, Wiley Blackwell, vol. 101(3), pages 337-61, September.
    7. Sharon Kozicki, 1999. "How useful are Taylor rules for monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 5-33.
    8. Gert Peersman & Frank Smets, 1999. "Uncertainty and the Taylor rule in a simple model of the Euro-area economy," Proceedings, Federal Reserve Bank of San Francisco.
    9. Stephen Poloz & David Rose & Robert Tetlow, 1994. "The Bank of Canada's new Quarterly Projection Model (QPM): An introduction," Bank of Canada Review, Bank of Canada, vol. 1994(Autumn), pages 23-38.
    10. Laurence Ball, 1997. "Efficient Rules for Monetary Policy," NBER Working Papers 5952, National Bureau of Economic Research, Inc.
    11. Ann-Charlotte Eliasson & Peter Isard & Douglas Laxton, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," IMF Working Papers 99/75, International Monetary Fund.
    12. Srour, Gabriel, 1999. "Inflation Targeting under Uncertainty," Technical Reports 85, Bank of Canada.
    13. Amano, Robert & Coletti , Don & Murchison , Stephen, 2000. "Empirical Estimation and the Quarterly Projection Model: An Example Focusing on the External Sector," Working Paper Series 104, Sveriges Riksbank (Central Bank of Sweden).
    14. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
    15. Murray, John & Mark Zelmer & Zahir Antia, 2000. "International Financial Crises and Flexible Exchange Rates: Some Policy Lessons from Canada," Technical Reports 88, Bank of Canada.
    16. Armstrong, John & Black, Richard & Laxton, Douglas & Rose, David, 1998. "A robust method for simulating forward-looking models," Journal of Economic Dynamics and Control, Elsevier, vol. 22(4), pages 489-501, April.
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    Cited by:
    1. Denise Côté & John Kuszczak & Jean-Paul Lam & Ying Liu & Pierre St-Amant, 2003. "A Comparison of Twelve Macroeconomic Models of the Canadian Economy," Technical Reports 94, Bank of Canada.
    2. Denise Côté & John Kuszczak & Jean-Paul Lam & Ying Liu & Pierre St-Amant, 2004. "The performance and robustness of simple monetary policy rules in models of the Canadian economy," Canadian Journal of Economics, Canadian Economics Association, vol. 37(4), pages 978-998, November.
    3. Kevin Clinton, 2006. "Wicksell at the Bank of Canada," Working Papers 1087, Queen's University, Department of Economics.
    4. Gabriel Srour, 2003. "Some Notes on Monetary Policy Rules with Uncertainty," Working Papers 03-16, Bank of Canada.
    5. Nicholas Rowe & David Tulk, 2003. "A Simple Test of Simple Rules: Can They Improve How Monetary Policy is Implemented with Inflation Targets?," Working Papers 03-31, Bank of Canada.
    6. Scott Hendry & Wai-Ming Ho & Kevin Moran, 2003. "Simple Monetary Policy Rules in an Open-Economy, Limited-Participation Model," Working Papers 03-38, Bank of Canada.

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