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Estimated, Calibrated, and Optimal Interest Rate Rules

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Abstract

Estimated, calibrated, and optimal interest rate rules are examined for their ability to dampen economic fluctuations caused by random shocks. A tax rate rule is also considered. The results show that the estimated interest rate rule used in the paper is stable for the period beginning in 1954 except for the early Volcker period, although more observations, especially high inflation ones, are needed before much confidence can be placed on the results. The models used for the stabilization results are large scale structural macroeconometric models, and some of the results differ from those based on small models. For example, rules with inflation coefficients less than one are not destabilizing, and rules with large inflation coefficients, such as the Taylor rule, achieve a small reduction in inflation variability at a cost of a large increase in interest rate variability.

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File URL: http://cowles.econ.yale.edu/P/cd/d12b/d1258.pdf
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Bibliographic Info

Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1258.

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Length: 40 pages
Date of creation: May 2000
Date of revision:
Handle: RePEc:cwl:cwldpp:1258

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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Keywords: Interest rate rules; optimal control;

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References

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  1. Ray C. Fair & John B. Taylor, 1989. "Full Information Estimation and Stochastic Simulation of Models with Rational Expectations," Cowles Foundation Discussion Papers 921, Cowles Foundation for Research in Economics, Yale University.
  2. Robert E. Hall & N. Gregory Mankiw, 1993. "Nominal Income Targeting," NBER Working Papers 4439, National Bureau of Economic Research, Inc.
  3. Fair, Ray C. & Howrey, E. Philip, 1996. "Evaluating alternative monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 38(2), pages 173-193, October.
  4. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 263-318 National Bureau of Economic Research, Inc.
  5. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  6. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  7. Martin Feldstein & James H. Stock, 1993. "The Use of Monetary Aggregate to Target Nominal GDP," NBER Working Papers 4304, National Bureau of Economic Research, Inc.
  8. Ray C. Fair & John B. Taylor, 1980. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Cowles Foundation Discussion Papers 564, Cowles Foundation for Research in Economics, Yale University.
  9. Ann-Charlotte Eliasson & Peter Isard & Douglas Laxton, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," IMF Working Papers 99/75, International Monetary Fund.
  10. Dean Croushore & Tom Stark, 1994. "Evaluating McCallum's rule for monetary policy," Working Papers 94-26, Federal Reserve Bank of Philadelphia.
  11. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  12. Andrews, Donald W K & Fair, Ray C, 1988. "Inference in Nonlinear Econometric Models with Structural Change," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 615-39, October.
  13. James W. Christian, 1968. "A Further Analysis Of The Objectives Of American Monetary Policy," Journal of Finance, American Finance Association, vol. 23(3), pages 465-477, 06.
  14. Glenn D. Rudebusch, 2001. "Is The Fed Too Timid? Monetary Policy In An Uncertain World," The Review of Economics and Statistics, MIT Press, vol. 83(2), pages 203-217, May.
  15. Stephen K. McNees, 1986. "Modeling the Fed: a forward- looking monetary policy reaction function," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 3-8.
  16. Taylor, John B., 1985. "What would nominal GNP targetting do to the business cycle?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 61-84, January.
  17. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
  18. Hendry, David F. & Pagan, Adrian R. & Sargan, J.Denis, 1984. "Dynamic specification," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 2, chapter 18, pages 1023-1100 Elsevier.
  19. repec:sae:niesru:v:164:y::i:1:p:90-99 is not listed on IDEAS
  20. Todd E. Clark, 1994. "Nominal GDP targeting rules: can they stabilize the economy?," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 11-25.
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Cited by:
  1. Jiri Podpiera, 2006. "The Role of Policy Rule Misspecification in Monetary Policy Inertia Debate," CERGE-EI Working Papers wp315, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  2. Jonathan L. Willis, 2003. "Implications of structural changes in the U.S. economy for pricing behavior and inflation dynamics," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 5-27.
  3. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  4. Ray C. Fair, 2001. "Actual Federal Reserve policy behavior and interest rate rules," Economic Policy Review, Federal Reserve Bank of New York, issue Mar, pages 61-72.

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