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Monetary policy deviations: A Bayesian state-space analysis

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  • Scott, C. Patrick
  • Barari, Mahua

Abstract

The following paper contributes to a growing body of literature examining the degree to which monetary policy deviates from a systematic rule. We extend an error correction model of the Fed's reaction function by Judd and Rudebusch (1998) by endogenizing the unobserved inflation target in a model that nests the constant target model as a special case. The model is iteratively updated using a Kalman filter and estimated using Bayesian methods. The draws from the posterior distribution are used to estimate a distribution of Taylor rules with which to compare observed policy and more appropriately estimate deviations. This approach more accurately represents the parameter space given our data. Estimates imply a significant deviation in Fed policy over the years preceding the housing market decline. Restricted model variations imply no evidence of strict inflation targeting, but strict output gap targeting behavior cannot be ruled out over the Burns and Volcker tenure.

Suggested Citation

  • Scott, C. Patrick & Barari, Mahua, 2017. "Monetary policy deviations: A Bayesian state-space analysis," The Quarterly Review of Economics and Finance, Elsevier, vol. 63(C), pages 1-12.
    • Handle: RePEc:eee:quaeco:v:63:y:2017:i:c:p:1-12
    DOI: 10.1016/j.qref.2016.04.015
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    1. Boris Hofmann & Bilyana Bogdanova, 2012. "Taylor rules and monetary policy: a global "Great Deviation"?," BIS Quarterly Review, Bank for International Settlements, September.
    2. John B. Taylor, 2012. "Monetary Policy Rules Work and Discretion Doesn’t: A Tale of Two Eras," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(6), pages 1017-1032, September.
    3. John B. Taylor, 2012. "The Great Deviation," Book Chapters, in: Evan F. Koenig & Robert Leeson & George A. Kahn (ed.), The Taylor Rule and the Transformation of Monetary Policy, chapter 7, Hoover Institution, Stanford University.
    4. John B. Taylor, 2007. "Housing and monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 463-476.
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    7. John P. Judd & Glenn D. Rudebusch, 1998. "Taylor's rule and the Fed, 1970-1997," Economic Review, Federal Reserve Bank of San Francisco, pages 3-16.
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    More about this item

    Keywords

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    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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