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Monetary Policy in the Presence of Term Structure Effects

In: The Yield Curve and Financial Risk Premia

Author

Listed:
  • Felix Geiger

    (University of Hohenheim)

Abstract

In macroeconomics, the short-term interest rate is usually modeled as a monetary-policy reaction function to a set of macroeconomic variables. A deliberately simple functional form is the Taylor rule; it is the answer to a perennial question in monetary economics of how the monetary authority should implement policy in a systematic manner. Taylor (1993, 214) developed a “hypothetical but representative” rule by using the gap concept of inflation and output. The Taylor rate is 1.5 times inflation plus 0.5 times the output gap, plus 1. For the period between 1982 and 1992, the rule was successful in capturing the actual behavior of the US federal funds rate. As this period is widely regarded as a shift from a “passive” to an “active” stabilizing monetary policy regime, the rule has been used ever since to ask where monetary policy should head in response to fluctuations in inflation and real activity.

Suggested Citation

  • Felix Geiger, 2011. "Monetary Policy in the Presence of Term Structure Effects," Lecture Notes in Economics and Mathematical Systems, in: The Yield Curve and Financial Risk Premia, chapter 0, pages 159-193, Springer.
    • Handle: RePEc:spr:lnechp:978-3-642-21575-9_6
    DOI: 10.1007/978-3-642-21575-9_6
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