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"Taylored rules". Does one fit (or hide) all?

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Abstract

Modern monetary policymakers consider a huge amount of information to evaluate events and contingencies. Yet most research on monetary policy relies on simple instrument rules and one relevant underpinning for this choice is the good empirical fit of the Taylor rule. This paper challenges the solidness of this foundation. We investigate the way the coefficients of the Taylor-type rules change over time according to the evolution of general economic conditions. We model the Federal Reserve reaction function during the Greenspan’s tenure as a Logistic Smoothing Transition Regime model in which a series of economic meaningful transition variables drive the transition across monetary regimes. We argue that estimated linear rules are weighted averages of the actual rules working in the diverse monetary regimes, where the weights merely reflect the length and not necessarily the relevance of the regimes. Accordingly, an estimated linear Taylor-type reaction function tends to resemble the rule adopted in the longest regime. Thus, the actual presence of finer monetary policy regimes corrupts the general predictive and descriptive power of linear Taylor-type rules. These latter, by hiding the specific rules at work in the various finer regimes, lose utility directly with the uncertainty in the economy.

Suggested Citation

  • Cinzia Alcidi , Alessandro Flamini, Andrea Fracasso, 2005. ""Taylored rules". Does one fit (or hide) all?," IHEID Working Papers 04-2005, Economics Section, The Graduate Institute of International Studies, revised Apr 2006.
  • Handle: RePEc:gii:giihei:heiwp04-2005
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    Cited by:

    1. Nikolay Markov, 2010. "A Regime Switching Model for the European Central Bank," Research Papers by the Institute of Economics and Econometrics, Geneva School of Economics and Management, University of Geneva 10091, Institut d'Economie et Econométrie, Université de Genève.
    2. Nikolay Markov & Thomas Nitschka, 2013. "Estimating Taylor Rules for Switzerland: Evidence from 2000 to 2012," Working Papers 2013-08, Swiss National Bank.
    3. Nikolay Markov & Carlos de Porres, 2011. "Is the Taylor Rule Nonlinear? Empirical Evidence from a Semi-Parametric Modeling Approach," Research Papers by the Institute of Economics and Econometrics, Geneva School of Economics and Management, University of Geneva 11052, Institut d'Economie et Econométrie, Université de Genève.

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    Keywords

    Instrument Rules; LSTR; Monetary Policy Regime; Risk Management; Taylor Rule;

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