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Monetary Policy, Inflation and Unemployment

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To what extent did deviations from the Taylor rule between 2002 and 2006 help to promote price stability and maximum sustainable employment? To address that question, this paper estimates a New Keynesian model with unemployment and performs a counterfactual experiment where monetary policy strictly follows a Taylor rule over the period 2002:Q1 - 2006:Q4 The paper finds that such a policy would have generated a sizeable increase in unemployment and resulted in an undesirably low rate of inflation. Around mid-2004, when the counterfactual deviates the most from the actual series, the model indicates that the probability of an unemployment rate greater than 8 percent would have been as high as 80 percent, while the probability of an inflation rate above 1 percent would have been close to zero.

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File URL: http://www.rbnz.govt.nz/research_and_publications/discussion_papers/2010/dp10_14.pdf
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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 DP2010/14.

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Length: 55 p.
Date of creation: Dec 2010
Date of revision:
Handle: RePEc:nzb:nzbdps:2010/14

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  1. De Graeve, Ferre & Emiris, Marina & Wouters, Raf, 2009. "A structural decomposition of the US yield curve," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 545-559, May.
  2. Del Negro, Marco & Otrok, Christopher, 2007. "99 Luftballons: Monetary policy and the house price boom across U.S. states," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1962-1985, October.
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