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The Use and Abuse of Taylor Rules

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  • Robert Tchaidze
  • Alina Carare

Abstract

This paper draws attention to inconsistencies in estimating simple monetary policy rules and their implications for policy advice. We simulate a macroeconomic model with a backward reaction function similar to Taylor (1993). We estimate different versions of a policy rule, using these simulated data. Under certain circumstances, estimations document an illusionary presence of a lagged interest rate, or of forward-looking behavior. Our results are consistent with the fact that several authors found very different versions of monetary policy rules, all fitting the U.S. data well. We also survey the literature, providing a list of issues complicating practical use of Taylor rules.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/148.

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Length: 30
Date of creation: 01 Jul 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/148

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Keywords: Economic models; inflation; monetary policy; central bank; monetary policy rules; monetary economics; gdp deflator; real interest rate; money supply; nominal interest rate; monetary fund; money demand; inflation target; monetary authorities; optimal monetary policy; monetary policy decision; inflation-targeting; inflationary shock; price stability; high inflation; monetary models; price level; monetary policy rule; monetary regime; monetary regimes; inflation targeting; actual inflation; money growth; monetary policy reaction functions; monetary policy reaction function; macroeconomic stability; inflation rate; real rates; transmission of monetary policy; central bank monetary policy; inflation response;

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References

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  1. Blinder, Alan S, 1986. "More on the Speed of Adjustment in Inventory Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(3), pages 355-65, August.
  2. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series 1998-03, Board of Governors of the Federal Reserve System (U.S.).
  3. Trehan, Bharat & Wu, Tao, 2007. "Time-varying equilibrium real rates and monetary policy analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 31(5), pages 1584-1609, May.
  4. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
  5. Ann-Charlotte Eliasson & Peter Isard & Douglas Laxton, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," IMF Working Papers 99/75, International Monetary Fund.
  6. Robrt G. King & André Kurmann, 2002. "Expectations and the term structure of interest rates : evidence and implications," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 49-95.
  7. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
  8. 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.
  9. Athanasios Orphanides, 2003. "Historical monetary policy analysis and the Taylor rule," Finance and Economics Discussion Series 2003-36, Board of Governors of the Federal Reserve System (U.S.).
  10. Auray, Stéphane & Fève, Patrick, 2003. "Money Growth and Interest Rate Rules : Is There an Observational Equivalence?," IDEI Working Papers 232, Institut d'Économie Industrielle (IDEI), Toulouse.
  11. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 285-298, April.
  12. Eric Swanson, 2000. "On Signal Extraction and Non-Certainty-Equivalence in Optimal Monetary Policy Rules," Econometric Society World Congress 2000 Contributed Papers 1085, Econometric Society.
  13. English William B. & Nelson William R. & Sack Brian P., 2003. "Interpreting the Significance of the Lagged Interest Rate in Estimated Monetary Policy Rules," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-18, April.
  14. Sharon Kozicki, 1999. "How useful are Taylor rules for monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 5-33.
  15. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," NBER Working Papers 9419, National Bureau of Economic Research, Inc.
  16. John M. Roberts, 1998. "Inflation expectations and the transmission of monetary policy," Finance and Economics Discussion Series 1998-43, Board of Governors of the Federal Reserve System (U.S.).
  17. 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.
  18. Jondeau E. & Le Bihan H. & Galles C., 2004. "Assessing Generalized Method-of-Moments Estimates of the Federal Reserve Reaction Function," Journal of Business & Economic Statistics, American Statistical Association, vol. 22, pages 225-239, April.
  19. Kevin J. Lansing, 2002. "Real-time estimation of trend output and the illusion of interest rate smoothing," Economic Review, Federal Reserve Bank of San Francisco, pages 17-34.
  20. Laurence Ball, 2000. "Near-rationality and inflation in two monetary regimes," Proceedings, Federal Reserve Bank of San Francisco.
  21. Minford, Patrick & Perugini, Francesco & Srinivasan, Naveen, 2002. "Are interest rate regressions evidence for a Taylor rule?," Economics Letters, Elsevier, vol. 76(1), pages 145-150, June.
  22. 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.
  23. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
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