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Estimating a Taylor Rule for New Zealand with a time-varying neutral real rate

Many critics of the Taylor rule claim that it is inferior to inflation forecast based (IFB) rules because it is not forward-looking, is not aggressive enough, and because of uncertainty surrounding the output gap. Nevertheless, the Taylor rule serves a constructive purpose because it abstracts from the Bank's macroeconomic model, FPS, and its performance is robust across various economic models. The Taylor rule thus provides a useful cross-check to the IFB rule, whose recommendations necessarily rely on a particular model structure, its dynamics and specific judgements over the forecast horizon. Additionally, this paper contends that any interest rate rule or model must account for the fall in the ex-ante real interest rate and the non-stationarity of short-term rates in New Zealand. We show how the neutral real interest rate (NRR) in the Taylor rule drifts downward since the second quarter of 1988, and explain why this presents additional real-time difficulties for the Taylor rule.

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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2002/06.

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Length: 38p
Date of creation: May 2002
Date of revision:
Handle: RePEc:nzb:nzbdps:2002/06
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  1. McCallum, Bennett T., 1997. "Crucial issues concerning central bank independence," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 99-112, June.
  2. Aaron Drew & Benjamin Hunt, 1999. "Efficient simple policy rules and the implications of potential output uncertainty," Reserve Bank of New Zealand Discussion Paper Series G99/5, Reserve Bank of New Zealand.
  3. Thomas Laubach & John C. Williams, 2001. "Measuring the natural rate of interest," Finance and Economics Discussion Series 2001-56, Board of Governors of the Federal Reserve System (U.S.).
  4. Andrew Levin & Volker Wieland & John C. Williams, 2001. "The performance of forecast-based monetary policy rules under model uncertainty," Finance and Economics Discussion Series 2001-39, Board of Governors of the Federal Reserve System (U.S.).
  5. Huang, Angela & Margaritis, Dimitri & Mayes, David, 2001. "Monetary policy rules in practice: Evidence from New Zealand," Research Discussion Papers 18/2001, Bank of Finland.
  6. Victor Gaiduch & Ben Hunt, 2000. "Inflation Targeting Under Potential Output Uncertainty," IMF Working Papers 00/158, International Monetary Fund.
  7. Batini, Nicoletta & Nelson, Edward, 2000. "Optimal Horizons for Inflation Targeting," Working Paper Series 103, Sveriges Riksbank (Central Bank of Sweden).
  8. Benjamin Hunt, 2000. "Inflation Targeting Under Potential Output Uncertainty," Computing in Economics and Finance 2000 180, Society for Computational Economics.
  9. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 263-318 National Bureau of Economic Research, Inc.
  10. Aaron Drew & Ben Hunt, 1998. "The Forecasting and Policy System: stochastic simulations of the core model," Reserve Bank of New Zealand Discussion Paper Series G98/6, Reserve Bank of New Zealand.
  11. Paul Conway & Aaron Drew & Ben Hunt & Alasdair Scott, 1998. "Exchange rate effects and inflation targeting in a small open economy: a stochastic analysis using FPS," Reserve Bank of New Zealand Discussion Paper Series G99/4, Reserve Bank of New Zealand.
  12. Ann-Charlotte Eliasson & Peter Isard & Douglas Laxton, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," IMF Working Papers 99/75, International Monetary Fund.
  13. Brian Sack & Volker Wieland, 1999. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Finance and Economics Discussion Series 1999-39, Board of Governors of the Federal Reserve System (U.S.).
  14. Robert L. Hetzel, 2000. "The Taylor rule : is it a useful guide to understanding monetary policy?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 1-33.
  15. Victor Gaiduch & Benjamin Hunt, 2000. "Inflation targeting under potential output uncertainty," Reserve Bank of New Zealand Discussion Paper Series DP2000/08, Reserve Bank of New Zealand.
  16. W A Razzak, 2002. "Monetary policy and forecasting inflation with and without the output gap," Reserve Bank of New Zealand Discussion Paper Series DP2002/03, Reserve Bank of New Zealand.
  17. Aaron Drew & L Christopher Plantier, 2000. "Interest rate smoothing in New Zealand and other dollar bloc countries," Reserve Bank of New Zealand Discussion Paper Series DP2000/10, Reserve Bank of New Zealand.
  18. Alasdair Scott, 2000. "A multivariate unobserved components model of cyclical activity," Reserve Bank of New Zealand Discussion Paper Series DP2000/04, Reserve Bank of New Zealand.
  19. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August.
  20. Yuong Ha, 2000. "Uncertainty about the length of the monetary policy transmission lag: implications for monetary policy," Reserve Bank of New Zealand Discussion Paper Series DP2000/01, Reserve Bank of New Zealand.
  21. W A Razzak, 1997. "Testing the rationality of the National Bank of New Zealand's survey data," Reserve Bank of New Zealand Discussion Paper Series G97/5, Reserve Bank of New Zealand.
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