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Markov Switching and the Taylor Principle

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  • Christian Murray

    ()
    (University of Houston)

  • Nikolsko-Rzhevskyy Alex

    ()
    (Lehigh University)

  • Papell David

    ()
    (University of Houston)

Abstract

Early research on the Taylor rule typically divided the data exogenously into pre-Volcker and Volcker-Greenspan subsamples.  We contribute to the recent trend of endogenizing changes in monetary policy by estimating a real-time forward-looking Taylor rule with endogenous Markov switching coefficients and variance. The response of the interest rate to inflation is regime dependent, with the pre and post-Volcker samples containing monetary regimes where the Fed did and did not follow the Taylor principle. While the Fed consistently adhered to the Taylor principle before 1973 and after 1984, it followed the Taylor principle from 1975-1979 and did not follow the Taylor principle from 1980-1984.  We also find that the Fed only responded to real economic activity during the states in which the Taylor principle held.  Our results are consistent with the idea that exogenously dividing postwar monetary policy into pre-Volcker and post-Volcker samples misleading. The greatest qualitative difference between our results and recent research employing time varying parameters is that we find that the Fed did not adhere to the Taylor Principle during most of Paul Volcker’s tenure, a finding which accords with the historical record of monetary policy.

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Bibliographic Info

Paper provided by Department of Economics, University of Houston in its series Working Papers with number 2013-219-06.

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Date of creation: 05 Aug 2013
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Handle: RePEc:hou:wpaper:2013-219-06

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Postal: Houston TX 77023
Web page: http://www.uh.edu/class/economics/
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Keywords: Markov Switching; Taylor Principle; Taylor Rule;

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  1. Owyang, Michael T. & Ramey, Garey, 2001. "Regime Switching and Monetary Policy Measurement," University of California at San Diego, Economics Working Paper Series qt24q32688, Department of Economics, UC San Diego.
  2. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
  3. Nikolsko-Rzhevskyy, Alex & Papell, David H., 2012. "Taylor rules and the Great Inflation," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 903-918.
  4. Orphanides, Athanasios, 2004. "Monetary Policy Rules, Macroeconomic Stability, and Inflation: A View from the Trenches," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(2), pages 151-75, April.
  5. Chris Murray & Charles Nelson, 1998. "The Uncertain Trend in U.S. GDP," Discussion Papers in Economics at the University of Washington 0074, Department of Economics at the University of Washington.
  6. Christopher A. Sims & Tao Zha, 2006. "Were There Regime Switches in U.S. Monetary Policy?," American Economic Review, American Economic Association, vol. 96(1), pages 54-81, March.
  7. Troy Davig & Eric M. Leeper, 2007. "Fluctuating Macro Policies and the Fiscal Theory," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 247-316 National Bureau of Economic Research, Inc.
  8. Pier Francesco Asso & George A. Kahn & Robert Leeson, 2007. "The Taylor rule and the transformation of monetary policy," Research Working Paper RWP 07-11, Federal Reserve Bank of Kansas City.
  9. Cinzia Alcidi & Alessandro Flamini & Andrea Fracasso, 2011. "Policy Regime Changes, Judgment and Taylor rules in the Greenspan Era," Economica, London School of Economics and Political Science, vol. 78(309), pages 89-107, January.
  10. Marvin Goodfriend, 2007. "How the World Achieved Consensus on Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 47-68, Fall.
  11. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  12. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May.
  13. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
  14. Kim, Chang-Jin & Nelson, Charles R., 2006. "Estimation of a forward-looking monetary policy rule: A time-varying parameter model using ex post data," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1949-1966, November.
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