Non Linear Taylor Rules and Asymmetric Preferences in Central Banking - Evidence from the UK and the US

Objectives and Methodology: This paper explores theoretically and empirically the view that, due to asymmetric central bank preferences, Taylor rules are often non-linear and that the nature of those asymmetries changes over different policy regimes. Our theoretical model uses a standard New-Keynesian framework to establish equivalence relations between the shape of non-linearities in Taylor rules and asymmetries in monetary policy objectives. We then estimate and test these relations for the UK and the US over various subperiods by means of smooth transition regressions. Results: There is often evidence in favor of non-linear rules in both countries, and their character changes substantially over subperiods. The pre inflation targeting period in the UK is characterized by a concave rule supporting recession avoidance preferences, while the inflation targeting period is characterized by a convex rule supporting inflation avoidance preferences on the part of monetary policymakers. The inflationary Vietnam war era in the US displays a convex rule supporting inflation avoidance while the stable Greenspan period is characterized by a concave rule supporting recession avoidance on the part of the Fed. Our findings from both countries support the view that reaction functions and the symmetry properties of the underlying loss functions change in line with the main macro problem of the day.