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Taylor Rules in the Quarterly Projection Model

  • Jamie Armour
  • Ben Fung
  • Dinah Maclean

In recent years, there has been a lot of interest in Taylor-type rules. Evidence in the literature suggests that Taylor-type rules are optimal in a number of models and are fairly robust across different models. The reaction function in the Bank of Canada's Quarterly Projection Model (QPM) is an inflation-forecast-based (IFB) rule. A number of studies have suggested, however, that the optimality of IFB rules is very model-specific. Given this and concerns about model uncertainty, it seems logical to assess the performance of Taylor-type reaction functions in QPM. Therefore, we compare QPM's IFB rule with a simple Taylor rule as well as with two rules that include open-economy elements. Overall, our results suggest that Taylor-type rules do not perform well in QPM compared with the base-case IFB rule, since they are associated with significantly higher variabilities of inflation, output, and interest rates. However, of the Taylor-type rules considered, we find that a simple rule with a coefficient of 2 on the contemporaneous inflation gap (versus 0.5 in Taylor's original rule) and a coefficient of 0.5 on the output gap is the most appropriate. Furthermore, the gains from using open-economy rules seem to be limited.

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Paper provided by Bank of Canada in its series Staff Working Papers with number 02-1.

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Length: 48 pages
Date of creation: 2002
Date of revision:
Handle: RePEc:bca:bocawp:02-1
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  1. Frank Smets, 1998. "Output gap uncertainty: does it matter for the Taylor rule?," BIS Working Papers 60, Bank for International Settlements.
  2. Amano, Robert & Coletti , Don & Murchison , Stephen, 2000. "Empirical Estimation and the Quarterly Projection Model: An Example Focusing on the External Sector," Working Paper Series 104, Sveriges Riksbank (Central Bank of Sweden).
  3. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
  4. Peter Isard & Douglas Laxton & Ann-Charlotte Eliasson, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," International Tax and Public Finance, Springer, vol. 6(4), pages 537-577, November.
  5. Sharon Kozicki, 1999. "How useful are Taylor rules for monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 5-33.
  6. Robert Amano & Don Coletti & Tiff Macklem, 1999. "Monetary Rules When Economic Behaviour Changes," Cahiers de recherche CREFE / CREFE Working Papers 81, CREFE, Université du Québec à Montréal.
  7. Srour, Gabriel, 1999. "Inflation Targeting under Uncertainty," Technical Reports 85, Bank of Canada.
  8. Murray, John & Mark Zelmer & Zahir Antia, 2000. "International Financial Crises and Flexible Exchange Rates: Some Policy Lessons from Canada," Technical Reports 88, Bank of Canada.
  9. Stephen Poloz & David Rose & Robert Tetlow, 1994. "The Bank of Canada's new Quarterly Projection Model (QPM): An introduction," Bank of Canada Review, Bank of Canada, vol. 1994(Autumn), pages 23-38.
  10. Andrew T. Levin & Volker W. Wieland & John C. Williams, 1998. "Robustness of simple monetary policy rules under model uncertainty," Finance and Economics Discussion Series 1998-45, Board of Governors of the Federal Reserve System (U.S.).
  11. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, December.
  12. Svensson, Lars E.O., 1997. "Inflation Targeting: Some Extensions," Seminar Papers 625, Stockholm University, Institute for International Economic Studies.
  13. Armstrong, John & Black, Richard & Laxton, Douglas & Rose, David, 1998. "A robust method for simulating forward-looking models," Journal of Economic Dynamics and Control, Elsevier, vol. 22(4), pages 489-501, April.
  14. P Clark & D Laxton, 1997. "Phillips Curves," CEP Discussion Papers dp0344, Centre for Economic Performance, LSE.
  15. Laurence Ball, 1997. "Efficient Rules for Monetary Policy," NBER Working Papers 5952, National Bureau of Economic Research, Inc.
  16. Gert Peersman & Frank Smets, 1999. "Uncertainty and the Taylor rule in a simple model of the Euro-area economy," Proceedings, Federal Reserve Bank of San Francisco.
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