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Questioning The Taylor Rule

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  • Rodrigo De-Losso

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Abstract

This article estimates a forward-looking Taylor-rule-type reaction function exclusively during Greenspan’s tenure and shows a considerable loss in both magnitude and significance of the inflation coefficient compared with the extended sample that otherwise includes Volcker’s tenure. That fact indicates that the interest rate pushing up in the early 1980s drives the coefficient towards being greater than one, when in fact it varies. A key variable in determining its size is the output gap, which is unobservable. Therefore, the paper approaches the Kalman filter to estimate the Taylor rule reaction function jointly with output gap, in order to characterize the monetary policy in the U.S. from 1960 to 2005. The results show that the point estimation of inflation is overall smaller than one-toone when the sample is split into either before and after Volcker’s appointment as Federal Reserve chairman or before and after Greenspan’s tenure. When the model allows for a drifting inflation coefficient, then the estimate is barely greater than one and often negative. Such a dynamics matches up with Greenspan’s claim that monetary policy is discretionary and that the Federal Reserve does not follow any simple rule. Consequently, an inflation coefficient inferior to one may be associated with monetary stability, disrupting the Taylor’s principle.

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File URL: http://www.fea.usp.br/feaecon/RePEc/documentos/DeLosso22WP.pdf
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Bibliographic Info

Paper provided by University of São Paulo (FEA-USP) in its series Working Papers, Department of Economics with number 2012_22.

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Date of creation: 17 Sep 2012
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Handle: RePEc:spa:wpaper:2012wpecon22

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Keywords: Taylor rule; Kalman Filter; Hidden variables; GMM;

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References

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  1. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  2. 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.
  3. Athanasios Orphanides & John C. Williams, 2002. "Robust Monetary Policy Rules with Unknown Natural Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 63-146.
  4. Boivin, Jean, 2006. "Has U.S. Monetary Policy Changed? Evidence from Drifting Coefficients and Real-Time Data," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(5), pages 1149-1173, August.
  5. Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
  6. Rodrigo De-Losso, 2012. "Did The Taylor Rule Stabilize Inflation in Brazil?," Working Papers, Department of Economics 2012_21, University of São Paulo (FEA-USP).
  7. Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series 1998-50, Board of Governors of the Federal Reserve System (U.S.).
  8. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February.
  9. Davidson, Russell & MacKinnon, James G., 1993. "Estimation and Inference in Econometrics," OUP Catalogue, Oxford University Press, number 9780195060119.
  10. Athanasios Orphanides & Simon Van_Norden, 2000. "The Reliability of Output Gap Estimates in Real Time," Econometric Society World Congress 2000 Contributed Papers 0768, Econometric Society.
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  12. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  13. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
  14. Alan S. Blinder & Ricardo Reis, 2005. "Understanding the Greenspan Standard," Working Papers 88, Princeton University, Department of Economics, Center for Economic Policy Studies..
  15. Lars E. O. Svensson, 2003. "What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," NBER Working Papers 9421, National Bureau of Economic Research, Inc.
  16. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, May.
  17. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
  18. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
  19. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  20. Kuttner, Kenneth N, 1994. "Estimating Potential Output as a Latent Variable," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 361-68, July.
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Cited by:
  1. Colla, Ernesto & Kuhl Teles, Vladimir & Eduardo Balbino, Christian, 2010. "A política monetária brasileira sob o regime de metas de inflação," Textos para discussão 244, Escola de Economia de São Paulo, Getulio Vargas Foundation (Brazil).
  2. Rodrigo De-Losso, 2012. "Did The Taylor Rule Stabilize Inflation in Brazil?," Working Papers, Department of Economics 2012_21, University of São Paulo (FEA-USP).

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