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Did Greenspan Open Pandora's Box? Testing the Taylor Hypothesis and Beyond

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  • Palma, Nuno

Abstract

The Taylor hypothesis is the conjecture that the 2007-2009 financial crisis and the 2008-present downturn have been caused by loose monetary policy during 2002-2006. According to the Taylor hypothesis the Fed deviated from well-know rules of monetary policy-making over this period, and this deviation caused an inefficient boom and subsequent bust. I use a well know economic model of the US aggregate economy (Christiano, Eichenbaum and Evans 2005) to test this hypothesis. I interpret shocks as deviations from Taylor-type rules. I conclude that the Taylor hypothesis for the Taylor rule fails to reproduce observed fluctuations in the data. Output increases only 0.3% at maximum which occurs at 2004:Q2. In the data, the output gap was at it's maximum in 2006:Q3. However, the Taylor hypothesis modified to incorporate persistence in the policy rule can partly explain the boom of the economy after 2001.

Suggested Citation

  • Palma, Nuno, 2013. "Did Greenspan Open Pandora's Box? Testing the Taylor Hypothesis and Beyond," MPRA Paper 48197, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:48197
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes

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