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Questioning The Taylor Rule

Author

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  • Rodrigo De-Losso

Abstract

This article estimates a forward-looking Taylor-rule-type reaction function exclusively during Greenspan’s tenure and shows a considerable loss in both magnitude and significance of the inflation coefficient compared with the extended sample that otherwise includes Volcker’s tenure. That fact indicates that the interest rate pushing up in the early 1980s drives the coefficient towards being greater than one, when in fact it varies. A key variable in determining its size is the output gap, which is unobservable. Therefore, the paper approaches the Kalman filter to estimate the Taylor rule reaction function jointly with output gap, in order to characterize the monetary policy in the U.S. from 1960 to 2005. The results show that the point estimation of inflation is overall smaller than one-toone when the sample is split into either before and after Volcker’s appointment as Federal Reserve chairman or before and after Greenspan’s tenure. When the model allows for a drifting inflation coefficient, then the estimate is barely greater than one and often negative. Such a dynamics matches up with Greenspan’s claim that monetary policy is discretionary and that the Federal Reserve does not follow any simple rule. Consequently, an inflation coefficient inferior to one may be associated with monetary stability, disrupting the Taylor’s principle.

Suggested Citation

  • Rodrigo De-Losso, 2012. "Questioning The Taylor Rule," Working Papers, Department of Economics 2012_22, University of São Paulo (FEA-USP).
    • Handle: RePEc:spa:wpaper:2012wpecon22
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    File URL: http://www.repec.eae.fea.usp.br/documentos/DeLosso22WP.pdf
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    References listed on IDEAS

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    Cited by:

    1. Balbino, Christian Eduardo & Colla, Ernesto & Teles, Vladimir Kuhl, 2011. "A Política Monetária Brasileira sob o Regime de Metas de Inflação," Revista Brasileira de Economia - RBE, EPGE Brazilian School of Economics and Finance - FGV EPGE (Brazil), vol. 65(2), June.
    2. Rodrigo De-Losso, 2012. "Did The Taylor Rule Stabilize Inflation in Brazil?," Working Papers, Department of Economics 2012_21, University of São Paulo (FEA-USP).

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    More about this item

    Keywords

    Taylor rule; Kalman Filter; Hidden variables; GMM;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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