Monetary Policy and Taylor Reaction Functions: Business Cycles, Central Bank Governance and Central Bankers’ Preferences

A key tool has characterized monetary policy analysis over the past thirty years: the use of reaction functions. This paper aims to review the evolution of the economics of the monetary policy reaction function from Taylor’s (1993) seminal contribution to present day. The review is based on two assumptions: (1) the peculiar property of the Taylor rule as a flexible tool explains its pathbreaking nature given its capacity to test multiple economic and institutional cases; and (2) this property can be described using a theoretical four-pillar approach. In this approach, the reaction function is the fourth pillar, which represents the final outcome of three intertwined drivers – business-cycle dynamics, central bank governance and central bankers’ preferences – and is itself a feedback instrument rule. Then, given the macroeconomic conditions and the infrequent changes of the monetary regime, it is highlighted the role that the central bankers’ preferences has played at various points, describing how, after the founding conservative central banker was born, new members of the Taylor rule family progressively emerged: visionary, prudent, holistic and creative central bankers, respectively with their forward-looking, inertial, augmented, and shadow reaction functions. Finally the literature stresses that so far the true central bankers show a mixed attitude to adopt the flexible instrument rule perspective, particularly when they are confronted with the Odysseus versus Delphi dilemma.