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How useful are Taylor rules for monetary policy?

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  • Sharon Kozicki

Abstract

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.

Suggested Citation

  • Sharon Kozicki, 1999. "How useful are Taylor rules for monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, vol. 84(Q II), pages 5-33.
  • Handle: RePEc:fip:fedker:y:1999:i:qii:p:5-33:n:v.84no.2
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