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The Taylor Rule: A Spurious Regression?

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  • Österholm, Pär

    ()
    (Department of Economics)

Abstract

This paper investigates the econometric properties of the Taylor (1993) rule applied to U.S., Australian and Swedish data to judge its empirical relevance. Little attention has been paid to the time series properties of the data underlying interest rate rules, nor the estimations themselves, despite the rise in popularity of Taylor-like rules in both empirical and theoretical work. Unit root tests indicate that the variables commonly used in such modelling are likely to be integrated of order one or near integrated. Given that the variables in the Taylor rule are integrated of order one or near integrated processes, cointegration is a necessary condition both for consistent estimation of the parameters of the model and compatibility between the model and the data. Tests find little support for cointegration and, together with an out-of-sample forecast exercise, suggest that we should have serious doubts about the Taylor rule as a reasonable description of how monetary policy is conducted in the countries considered in this study. Parameter estimates from the standard Taylor rule regressions are therefore likely to be inconsistent and caution should be taken before for central bank policy is evaluated using such methods.

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Bibliographic Info

Paper provided by Uppsala University, Department of Economics in its series Working Paper Series with number 2003:20.

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Length: 28 pages
Date of creation: 15 Aug 2003
Date of revision:
Publication status: Published in Bulletin of Economic Research, 2005, pages 217-247.
Handle: RePEc:hhs:uunewp:2003_020

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Postal: Department of Economics, Uppsala University, P. O. Box 513, SE-751 20 Uppsala, Sweden
Phone: + 46 18 471 25 00
Fax: + 46 18 471 14 78
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Web page: http://www.nek.uu.se/
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Keywords: Monetary policy; Taylor rule; Cointegration;

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