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Why inflation targeting central banks seem to follow a standard Taylor rule

  • Kühn Stefan
  • Muysken Joan

    (METEOR)

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    Studies on central bank reaction functions find that central banks only caring about inflation stability, like the ECB, seem to follow a standard Taylor rule in the sense that the interest rate reacts significantly to variations in the output gap. We explain this result by claiming that the alleged reaction to the output gap could in fact be a reaction of the nominal interest rate to variations in the natural real rate of interest, which monetary policy should take into account. This provides a rationale for central banks to observe the output gap in the conduct of purely inflation targeting monetary policy.

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    File URL: http://digitalarchive.maastrichtuniversity.nl/fedora/objects/guid:16a027fb-8e0f-4120-85c5-9ae64f3916b0/datastreams/ASSET1/content
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    Paper provided by Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR) in its series Research Memorandum with number 058.

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    Date of creation: 2009
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    Handle: RePEc:unm:umamet:2009058
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    1. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
    2. Dupor, Bill, 2001. "Investment and Interest Rate Policy," Journal of Economic Theory, Elsevier, vol. 98(1), pages 85-113, May.
    3. Jean-Stephane Mesonnier & Jean-Paul Renne, 2004. "A Time Varying Natural Rate of Interest for the Euro Area," Money Macro and Finance (MMF) Research Group Conference 2004 42, Money Macro and Finance Research Group.
    4. Giammarioli, Nicola & Valla, Natacha, 2003. "The natural real rate of interest in the euro area," Working Paper Series 0233, European Central Bank.
    5. Paul M Romer, 1999. "Increasing Returns and Long-Run Growth," Levine's Working Paper Archive 2232, David K. Levine.
    6. Thomas Laubach & John C. Williams, 2003. "Measuring the Natural Rate of Interest," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 1063-1070, November.
    7. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    8. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    9. Janko Gorter & Jan Jacobs & Jakob de Haan, 2008. "Taylor Rules for the ECB using Expectations Data," Scandinavian Journal of Economics, Wiley Blackwell, vol. 110(3), pages 473-488, 09.
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