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Does the Federal Reserve Follow a Non-Linear Taylor Rule?

Author

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  • Kenneth Petersen

    (University of Connecticut)

Abstract

The Taylor rule has become one of the most studied strategies for monetary policy. Yet, little is known whether the Federal Reserve follows a non-linear Taylor rule. This paper employs the smooth transition regression model and asks the question: does the Federal Reserve change its policy-rule according to the level of inflation and/or the output gap? I find that the Federal Reserve does follow a non-linear Taylor rule and, more importantly, that the Federal Reserve followed a non-linear Taylor rule during the golden era of monetary policy, 1985-2005, and a linear Taylor rule throughout the dark age of monetary policy, 1960-1979. Thus, good monetary policy is associated with a non-linear Taylor rule: once inflation approaches a certain threshold, the Federal Reserve adjusts its policy-rule and begins to respond more forcefully to inflation.

Suggested Citation

  • Kenneth Petersen, 2007. "Does the Federal Reserve Follow a Non-Linear Taylor Rule?," Working papers 2007-37, University of Connecticut, Department of Economics.
    • Handle: RePEc:uct:uconnp:2007-37
    Note: I would like to thank Christian Zimmermann (adviser), Paul Beaumont, Steve Cunningham, and Philip Shaw for many good conversations about monetary policy and time series econometrics.
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    More about this item

    Keywords

    Taylor rule; Federal Reserve; non-linearity; monetary policy;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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