Nonlinearity and Structural Breaks in Monetary Policy Rules with Stock Prices
AbstractThis paper empirically examines how the Fed responds to stock prices and inflation movements, using the forward-looking Taylor rule augmented with the stock price gap. The typical linear policy reaction function has a substantial change after 1991, but lacks the robustness in that the estimation result is sensitive to a minor change of the sample period. To alleviate the problem, we allow for temporary and permanent variations of the reaction coefficients by introducing nonlinearity and a structural break. The time variation of the inflation coefficient shows that the Fed is more aggressive in periods of inflationary pressure. However, unlike the linear model case, we find little evidence of a significant change in the Fed's active response to inflationary pressure after the structural break at 1991:I. We also find a positive response to the stock price change after 1991:I. But the time varying pattern of the response is counter-cyclical to stock price change, which does not support the view that the Fed actively reacts to a stock price bubble.
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Bibliographic InfoPaper provided by University of Connecticut, Department of Economics in its series Working papers with number 2011-19.
Length: 31 pages
Date of creation: Oct 2011
Date of revision:
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Monetary policy rule; nonlinear model; stock market; structural break; and time varying coefficient;
Find related papers by JEL classification:
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-10-15 (All new papers)
- NEP-CBA-2011-10-15 (Central Banking)
- NEP-MAC-2011-10-15 (Macroeconomics)
- NEP-MON-2011-10-15 (Monetary Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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