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The Observational Equivalence of Taylor Rule and Taylor-Type Rules

  • Minford, Patrick
  • Perugini, Francesco
  • Srinivasan, Naveen

In the past few years the view has commonly been expressed that central banks follow `Taylor Rules' (as first promulgated by Henderson and McKibbin (1993)). We show that the appearance of such an interest rate rule – a ‘pseudo-Taylor rule’ – can be created by a standard macro model in which actually a money supply rule is operating with no interest rate feedback – i.e, where there is in fact no Taylor rule operating at all. Hence an interest equation does not identify a (structural) Taylor rule; a Taylor rule and a pseudo-rule, though corresponding to different structural models, are ‘observationally equivalent’ to use the expression coined by Thomas Sargent (1976). It remains an open question whether Taylor rules or money supply rules are appropriate from a welfare viewpoint.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2959.

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Date of creation: Sep 2001
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Handle: RePEc:cpr:ceprdp:2959
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  1. John B. Taylor, 2000. "Teaching Modern Macroeconomics at the Principles Level," American Economic Review, American Economic Association, vol. 90(2), pages 90-94, May.
  2. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
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  8. Frederic S. Mishkin, 1995. "Symposium on the Monetary Transmission Mechanism," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 3-10, Fall.
  9. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  10. Phelps, Edmund S & Taylor, John B, 1977. "Stabilizing Powers of Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 163-90, February.
  11. Minford, Patrick & Nowell, Eric & Webb, Bruce, 1999. "Nominal Contracts and Monetary Targets," CEPR Discussion Papers 2215, C.E.P.R. Discussion Papers.
  12. Sargent, Thomas J, 1976. "The Observational Equivalence of Natural and Unnatural Rate Theories of Macroeconomics," Journal of Political Economy, University of Chicago Press, vol. 84(3), pages 631-40, June.
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