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The Use and Abuse of Taylor Rules: How precisely can we estimate them?

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Author Info
Robert Tchaidze
Alina Carare

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Abstract

This paper surveys the economic literature on simple policy rules and analyzes econometric methods used to estimate them, emphasizing effects of model misspecification. We draw attention to inconsistencies in evaluation of the rules and implications for policy advice, which is commonly done based on benchmark rules that could be improperly estimated, or selected for a wrong reason. We simulate a simple macroeconomic model with an interest rate obtained from a simple policy reaction function similar to Taylor (1993). We estimate different versions of the simple policy rule, using the simulated data. Estimations document illusionary presence of extra variables, such as lagged interest rate, output gap growth, and inflation differential; or claim the policy function to be forward looking. Length of the sample or ignorance of real time data errors do not seem to have significant impact on the results.

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Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 132.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:latm04:132

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Related research
Keywords: monetary policy rules; central bank; monetary policy; Taylor rules;

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Find related papers by JEL classification:
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

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Troy Davig & Jeffrey R. Gerlach, 2006. "State-Dependent Stock Market Reactions to Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December. [Downloadable!]
  2. Mandler, Martin, 2006. "Are there gains from including monetary aggregates and stock market indices in the monetary policy reaction function? A simulation study of recent U.S. monetary policy," MPRA Paper 2318, University Library of Munich, Germany. [Downloadable!]
  3. Glenn D. Rudebusch, 2005. "Monetary policy inertia: fact or fiction?," Working Papers in Applied Economic Theory 2005-19, Federal Reserve Bank of San Francisco. [Downloadable!]
    Other versions:
  4. Páez-Farrell, Juan, 2007. "Monetary Policy Rules in Theory and in Practice: Evidence from the UK and the US," Cardiff Economics Working Papers E2007/13, Cardiff University, Cardiff Business School, Economics Section. [Downloadable!]
    Other versions:
  5. Alexander Mihailov, 2007. "Does Instrument Independence Matter under the Constrained Discretionof an Inflation Targeting Goal? Lessons from UK Taylor Rule Empirics," Money Macro and Finance (MMF) Research Group Conference 2006 95, Money Macro and Finance Research Group. [Downloadable!]
  6. Carrillo, Julio A., 2008. "Comment on Identification with Taylor Rules: is it indeed impossible? Extended version," Research Memoranda 034, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
  7. Martin Cihák & Katerina Smídková & Ales Bulir, 2008. "Writing Clearly: ECB’s Monetary Policy Communication," IMF Working Papers 08/252, International Monetary Fund. [Downloadable!]
  8. Brooks, Robert & Harris, Mark & Spencer, Christopher, 2007. "An Inflated Ordered Probit Model of Monetary Policy: Evidence from MPC Voting Data," MPRA Paper 8509, University Library of Munich, Germany. [Downloadable!]
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