Conference Paper

No-arbitrage Taylor rules

Abstract: We estimate Taylor (1993) rules and identify monetary policy shocks using no-arbitrage pricing techniques. Long-term interest rates are risk-adjusted expected values of future short rates and thus provide strong over-identifying restrictions about the policy rule used by the Federal Reserve. The no-arbitrage framework also accommodates backward-looking and forward-looking Taylor rules. We find that inflation and GDP growth account for over half of the time-variation of yield levels and we attribute almost all of the movements in the term spread to inflation. Taylor rules estimated with no-arbitrage restrictions differ substantially from Taylor rules estimated by OLS and monetary policy shocks identified with no-arbitrage techniques are less volatile than their OLS counterparts.

Keywords: Taylor's rule; Monetary policy; Fiscal policy;

Status: Published in Fiscal and Monetary Policy : a conference (2005: March 4-5)

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Proceedings

Publication Date: 2005