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How useful are Taylor rules for monetary policy?

  • Sharon Kozicki

Over the past several years, Taylor rules have attracted increased attention of analysts, policymakers, and the financial press. Taylor rules recommend a setting for the level of the federal funds rate based on the state of the economy. Taylor rules have become more appealing recently with the apparent breakdown in the relationship between money growth and inflation. But, the usefulness of rule recommendations to policymakers has not been well established.> To be useful to policymakers, rule recommendations should be robust to minor variations in the rule specification. For example, if recommendations differ considerably depending on whether price inflation is measured using the core consumer price index or the chain price index for GDP, then the rule may not be very useful. Rule recommendations should also be reliable. A reliable rule might be expected to replicate federal funds rate settings over a period when policymakers thought policy actions were successful. But, even a rule that can replicate favorable policy actions may not be regarded as reliable if past policy decisions were influenced by economic events beyond the scope of the rule.> Kozicki examines whether recommendations from Taylor rules are useful to policymakers as they decide how to adjust the federal funds rate. She suggests that the usefulness of Taylor rule recommendations to policymakers faced with real-time policy decisions is limited. But Taylor rules may be useful to policymakers in other ways. For example, Taylor rules may provide a good starting point for discussions of issues that concern policymakers. Such rules also play an important role in most forecasting models.

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Article provided by Federal Reserve Bank of Kansas City in its journal Economic Review.

Volume (Year): (1999)
Issue (Month): Q II ()
Pages: 5-33

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Handle: RePEc:fip:fedker:y:1999:i:qii:p:5-33:n:v.84no.2
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  1. Kenneth N. Kuttner, 1992. "Monetary policy with uncertain estimates of potential output," Economic Perspectives, Federal Reserve Bank of Chicago, issue Jan, pages 2-15.
  2. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
  3. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers 1750, C.E.P.R. Discussion Papers.
  4. Stephen G. Cecchetti, 1998. "Policy rules and targets: framing the central banker's problem," Economic Policy Review, Federal Reserve Bank of New York, issue Jun, pages 1-14.
  5. Stephen K. McNees, 1986. "Modeling the Fed: a forward- looking monetary policy reaction function," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 3-8.
  6. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
  7. Bennett T. McCallum & Edward Nelson, 1999. "Performance of Operational Policy Rules in an Estimated Semiclassical Structural Model," NBER Chapters, in: Monetary Policy Rules, pages 15-56 National Bureau of Economic Research, Inc.
  8. Pierre Duguay & Stephen Poloz, 1994. "The Role of Economic Projections in Canadian Monetary Policy Formulation," Canadian Public Policy, University of Toronto Press, vol. 20(2), pages 189-199, June.
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