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Empirical Evidence on the Generalized Taylor Principle

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  • Mario Jovanovic

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    Abstract

    During financial crises central banks usually decrease interest rates in order to reduce financial uncertainty. This behavior increases inflation risk. The trade-off between inflation and uncertainty stabilization can be modeled by the generalized Taylor rule, which describes inflation sensitivity as a function of financial uncertainty instead of a constant parameter. Based on the GMM-estimation of the generalized approach I confirm the suggested uncertainty-dependent inflation sensitivity of the Fed. Prolonged deviations from the Taylor principle are not evident. This implies that the Fed does not deemphasize inflation stabilization in favor of uncertainty stabilization – especially during the peak of the latest sub-prime crisis.

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    File URL: http://repec.rwi-essen.de/files/REP_12_334.pdf
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    Bibliographic Info

    Paper provided by Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen in its series Ruhr Economic Papers with number 0334.

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    Length: 9 pages
    Date of creation: Apr 2012
    Date of revision:
    Handle: RePEc:rwi:repape:0334

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    Keywords: Financial instability; time-varying inflation sensitivity;

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    1. Nicholas Bloom, 2007. "The Impact of Uncertainty Shocks," NBER Working Papers 13385, National Bureau of Economic Research, Inc.
    2. David Andolfatto & Paul Gomme, 2003. "Monetary Policy Regimes and Beliefs," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 1-30, February.
    3. Leeper, Eric M. & Zha, Tao, 2003. "Modest policy interventions," Journal of Monetary Economics, Elsevier, vol. 50(8), pages 1673-1700, November.
    4. Troy Davig & Eric M. Leeper, 2005. "Generalizing the Taylor Principle," NBER Working Papers 11874, National Bureau of Economic Research, Inc.
    5. Ruge-Murcia, Francisco J, 1995. "Credibility and Changes in Policy Regime," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 176-208, February.
    6. Davig, Troy, 2004. "Regime-switching debt and taxation," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 837-859, May.
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