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The Observational Equivalence of Taylor Rule and Taylor-Type Rules

Listed author(s):
  • 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
Handle: RePEc:cpr:ceprdp:2959
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  1. McCallum, B.T. & Nelson, E., 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Papers 644, Stockholm - International Economic Studies.
  2. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
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  7. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
  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. Bennett T. McCallum & Edward Nelson, "undated". "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," GSIA Working Papers 1997-71, Carnegie Mellon University, Tepper School of Business.
  10. Minford, Patrick & Nowell, Eric & Webb, Bruce, 1999. "Nominal Contracts and Monetary Targets," CEPR Discussion Papers 2215, C.E.P.R. Discussion Papers.
  11. Thomas J. Sargent, 1975. "The observational equivalence of natural and unnatural rate theories of macroeconomics," Working Papers 48, Federal Reserve Bank of Minneapolis.
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