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Estimating a Taylor Rule for New Zealand with a time-varying neutral real rate

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Abstract

Many critics of the Taylor rule claim that it is inferior to inflation forecast based (IFB) rules because it is not forward-looking, is not aggressive enough, and because of uncertainty surrounding the output gap. Nevertheless, the Taylor rule serves a constructive purpose because it abstracts from the Bank's macroeconomic model, FPS, and its performance is robust across various economic models. The Taylor rule thus provides a useful cross-check to the IFB rule, whose recommendations necessarily rely on a particular model structure, its dynamics and specific judgements over the forecast horizon. Additionally, this paper contends that any interest rate rule or model must account for the fall in the ex-ante real interest rate and the non-stationarity of short-term rates in New Zealand. We show how the neutral real interest rate (NRR) in the Taylor rule drifts downward since the second quarter of 1988, and explain why this presents additional real-time difficulties for the Taylor rule.

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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2002/06.

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Length: 38p
Date of creation: May 2002
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Handle: RePEc:nzb:nzbdps:2002/06

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  1. Batini, Nicoletta & Nelson, Edward, 2000. "Optimal Horizons for Inflation Targeting," Working Paper Series 103, Sveriges Riksbank (Central Bank of Sweden).
  2. Huang, Angela & Margaritis, Dimitri & Mayes, David, 2001. "Monetary policy rules in practice: Evidence from New Zealand," Research Discussion Papers 18/2001, Bank of Finland.
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Cited by:
  1. Horváth, Roman, 2009. "The time-varying policy neutral rate in real-time: A predictor for future inflation?," Economic Modelling, Elsevier, vol. 26(1), pages 71-81, January.
  2. Buckle, Robert A. & Kim, Kunhong & Kirkham, Heather & McLellan, Nathan & Sharma, Jarad, 2007. "A structural VAR business cycle model for a volatile small open economy," Economic Modelling, Elsevier, vol. 24(6), pages 990-1017, November.
  3. Bhansali, Vineer & Dorsten, Matthew P. & Wise, Mark B., 2009. "Asymmetric monetary policy and the yield curve," Journal of International Money and Finance, Elsevier, vol. 28(8), pages 1408-1425, December.
  4. Willy Chetwin & Amy Wood, 2013. "Neutral interest rates in the post-crisis period," Reserve Bank of New Zealand Analytical Notes series AN2013/07, Reserve Bank of New Zealand.
  5. Belke, Ansgar & Klose, Jens, 2013. "Modifying Taylor reaction functions in the presence of the zero‐lower‐bound — Evidence for the ECB and the Fed," Economic Modelling, Elsevier, vol. 35(C), pages 515-527.
  6. Yüksel, Ebru & Metin-Ozcan, Kivilcim & Hatipoglu, Ozan, 2013. "A survey on time-varying parameter Taylor rule: A model modified with interest rate pass-through," Economic Systems, Elsevier, vol. 37(1), pages 122-134.
  7. Liu, Philip, 2010. "Stabilization bias for a small open economy: The case of New Zealand," Journal of Macroeconomics, Elsevier, vol. 32(3), pages 921-935, September.
  8. Basdevant, Olivier, 2005. "Learning process and rational expectations: An analysis using a small macro-economic model for New Zealand," Economic Modelling, Elsevier, vol. 22(6), pages 1074-1089, December.
  9. Weshah Razzak, 2014. "New Zealand Labour Market Dynamics: Pre- and Post-global Financial Crisis," Treasury Working Paper Series 14/03, New Zealand Treasury.

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