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The Taylor principle, interest rate smoothing and Fed policy in the 1970s and 1980s

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  • Yash P. Mehra

Abstract

Using real time estimates of output gaps or Greenbook forecasts of the unemployment rate, this article estimates Taylor-type policy rules that predict the actual behavior of the funds rate during two sample periods, 1968Q1 to 1979Q2 and 1979Q3 to 1994Q4. The inflation rate response coefficient is close to unity over the first sub-period and well above unity over the second, suggesting Fed policy violated the Taylor principle during the first period. The adjustment of the funds rate in response to fundamentals is not as rapid during the first period as it is during the second. Together these results support the conventional view that the Fed was \"too timid\" and \"too sluggish\" during the late 1960s and the 1970s. Though the Fed smoothes interest rates, the degree of smoothing exhibited is far less than what was previously estimated. The funds rate response to its fundamentals is complete within one year during the first period and within one quarter during the second.

Suggested Citation

  • Yash P. Mehra, 2002. "The Taylor principle, interest rate smoothing and Fed policy in the 1970s and 1980s," Working Paper 02-03, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:02-03
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    References listed on IDEAS

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    Cited by:

    1. Karel Brůna, 2009. "Měnová politika a predikce variability úrokových sazeb na peněžním trhu [Monetary policy and prediction of variability]," Politická ekonomie, Prague University of Economics and Business, vol. 2009(3), pages 361-382.
    2. Bruna, Karel & Tran, Quang Van, 2020. "The central banks’ ability to control variability of money market interest rates: The case of inflation targeting countries," Journal of Economic Behavior & Organization, Elsevier, vol. 176(C), pages 384-402.
    3. Salisu, Afees A. & Gupta, Rangan & Kim, Won Joong, 2022. "Exchange rate predictability with nine alternative models for BRICS countries," Journal of Macroeconomics, Elsevier, vol. 71(C).

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    Keywords

    Interest rates; Monetary policy;

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