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The Taylor rule: can it be supported by the data?

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  • Leon, Costas

Abstract

The Taylor equation is a simple monetary policy rule that determines the Central Bank’s policy rate as a function of inflation and output. A significant body of literature verifies the consistency of the Taylor rule with the data. However, recently there has been a growing literature regarding the validity of the estimated parameters due to the non-stationarity of the interest rate. In this paper I test the consistency of the Taylor rule with the Greek data for the period 1996-2004. It appears that the data do not support the Taylor rule in the sense that they do not form a cointegration set of variables. Therefore, the estimated parameters should be considered fragile and the forecasting for the interest rate as a function of inflation and output should not be expected to be adequately consistent with the actual data.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 1650.

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Date of creation: 31 Aug 2006
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Handle: RePEc:pra:mprapa:1650

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Keywords: Taylor rule; Monetary policy; Central bank; EMU; Greece;

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  1. Gerlach, Stefan & Schnabel, Gert, 2000. "The Taylor rule and interest rates in the EMU area," Economics Letters, Elsevier, vol. 67(2), pages 165-171, May.
  2. Robert J. Hodrick & Edward Prescott, 1981. "Post-War U.S. Business Cycles: An Empirical Investigation," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 451, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Jon Faust & John H. Rogers & Jonathan H. Wright, 2001. "An empirical comparison of Bundesbank and ECB monetary policy rules," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 705, Board of Governors of the Federal Reserve System (U.S.).
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  15. Gerdesmeier, Dieter & Roffia, Barbara, 2003. "Empirical estimates of reaction functions for the euro area," Working Paper Series 0206, European Central Bank.
  16. Gert Peersman & Frank Smets, 1999. "Uncertainty and the Taylor rule in a simple model of the Euro-area economy," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco.
  17. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
  18. Gert Schnabel & Stefan Gerlach, 1999. "The Taylor rule and interest rates in the EMU area: a note," BIS Working Papers 73, Bank for International Settlements.
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