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The market-perceived monetary policy rule

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  • James D. Hamilton
  • Seth Pruitt
  • Scott C. Borger

Abstract

We introduce a novel method for estimating a monetary policy rule using macroeconomic news. Market forecasts of both economic conditions and monetary policy are affected by news, and our estimation links the two effects. This enables us to estimate directly the policy rule agents use to form their expectations, and in so doing flexibly capture the particular dynamics of policy response. We find evidence that between 1994 and 2007 the market-perceived Federal Reserve policy rule changed: the output response vanished, and the inflation response path became more gradual but larger in long-run magnitude. In a standard model we show that output smoothing caused by a larger inflation response magnitude is offset by the more measured pace of response. Our response coefficient estimates are robust to measurement and theoretical issues with both potential output and the inflation target.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 982.

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Date of creation: 2009
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Handle: RePEc:fip:fedgif:982

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Keywords: Monetary policy - United States ; Economic forecasting - United States;

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References

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  1. Athanasios Orphanides & Simon van Norden, 2001. "The Unreliability of Output Gap Estimates in Real Time," CIRANO Working Papers 2001s-57, CIRANO.
  2. Jon Faust & John H. Rogers & Shing-Yi B. Wang & Jonathan H. Wright, 2003. "The high-frequency response of exchange rates and interest rates to macroeconomic announcements," International Finance Discussion Papers 784, Board of Governors of the Federal Reserve System (U.S.).
  3. Adrian Pagan, 1985. "Two Stage and Related Estimators and Their Applications," Cowles Foundation Discussion Papers 741, Cowles Foundation for Research in Economics, Yale University.
  4. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  5. Andrew Ang & Sen Dong & Monika Piazzesi, 2007. "No-Arbitrage Taylor Rules," NBER Working Papers 13448, National Bureau of Economic Research, Inc.
  6. Monika Piazzesi & Eric Swanson, 2004. "Futures Prices as Risk-adjusted Forecasts of Monetary Policy," NBER Working Papers 10547, National Bureau of Economic Research, Inc.
  7. Hamilton, James D., 2008. "Daily monetary policy shocks and new home sales," Journal of Monetary Economics, Elsevier, vol. 55(7), pages 1171-1190, October.
  8. Michael Owyang & Garey Ramey, 2003. "Regime switching and monetary policy measurement," Working Papers 2001-002, Federal Reserve Bank of St. Louis.
  9. 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.
  10. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
  11. Josephine M. Smith & John B. Taylor, 2007. "The Long and the Short End of the Term Structure of Policy Rules," NBER Working Papers 13635, National Bureau of Economic Research, Inc.
  12. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March.
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Cited by:
  1. Tara M. Sinclair & Edward N. Gamber & H.O. Stekler & Elizabeth Reid, 2008. "Jointly Evaluating the Federal Reserve’s Forecasts of GDP Growth and Inflation," Working Papers 2008-002, The George Washington University, Department of Economics, Research Program on Forecasting, revised Mar 2011.
  2. Fernanda Nechio & Carlos Carvalho, 2012. "Do People Understand Monetary Policy?," 2012 Meeting Papers 426, Society for Economic Dynamics.
  3. Jeffrey R. Campbell & Charles L. Evans & Jonas D.M. Fisher & Alejandro Justiniano, 2012. "Macroeconomic Effects of Federal Reserve Forward Guidance," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 44(1 (Spring), pages 1-80.
  4. James D. Hamilton & Seth Pruitt & Scott Borger, 2011. "Estimating the Market-Perceived Monetary Policy Rule," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(3), pages 1-28, July.
  5. Michael D. Bauer, 2011. "Nominal interest rates and the news," Working Paper Series 2011-20, Federal Reserve Bank of San Francisco.
  6. Di Maggio, Marco, 2010. "The Political Economy of the Yield Curve," MPRA Paper 20697, University Library of Munich, Germany.
  7. Nikolay Markov & Thomas Nitschka, 2013. "Estimating Taylor Rules for Switzerland: Evidence from 2000 to 2012," Working Papers 2013-08, Swiss National Bank.

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