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Working Paper
Taylor Rule Estimation by OLS
Ordinary Least Squares (OLS) estimation of monetary policy rules produces potentially inconsistent estimates of policy parameters. The reason is that central banks react to variables, such as inflation and the output gap, that are endogenous to monetary policy shocks. Endogeneity implies a correlation between regressors and the error term – hence, an asymptotic bias. In principle, Instrumental Variables (IV) estimation can solve this endogeneity problem. In practice, however, IV estimation poses challenges, as the validity of potential instruments depends on various unobserved features of ...
Discussion Paper
Assessing monetary accommodation: a simple empirical model of monetary policy and its implications for unemployment and inflation
This note suggests that household wealth growth and a long-forward interest rate can be used to construct a simple and convenient reference standard for assessing the current stance of monetary policy. It shows that the difference between the federal funds rate and this reference interest rate is a powerful predictor of the unemployment rate and inflation, producing real-time forecasts that are competitive with consensus-based forecasts from surveys of forecasting professionals. Moreover, one can understand past FOMC policy actions as efforts to adjust the stance of policy, so measured, in ...
Output Gaps, the Taylor Rule and the Stance of Monetary Policy
The Taylor rule offers a formula to calculate a prescribed policy rate. How do alternative measures of the output gap affect this prescribed rate?
Working Paper
Asymmetry, Complementarities, and State Dependence in Federal Reserve Forecasts
Forecasts are a central component of policy making; the Federal Reserve''s forecasts are published in a document called the Greenbook. Previous studies of the Greenbook''s inflation forecasts have found them to be rationalizable but asymmetric if considering particular sub-periods, e.g., before and after the Volcker appointment. In these papers, forecasts are analyzed in isolation, assuming policymakers value them independently. We analyze the Greenbook fore- casts in a framework in which the forecast errors are allowed to interact. We find that allowing the losses to interact makes the ...
Working Paper
Optimal monetary policy regime switches
Given regime switches in the economy?s growth rate, optimal monetary policy rules may respond by switching policy parameters. These optimized parameters differ across regimes and from the optimal choice under fixed regimes, particularly in the inflation target and interest rate inertia. Optimal switching rules produce welfare gains relative to constant rules, with switches in the implicit real interest rate used for policy and the degree of interest rate inertia producing the largest gains. However, gains from switching rules decrease if the monetary authority trades-off the probability of ...
Discussion Paper
A Look at the Accuracy of Policy Expectations
Since the 1980s, the primary policy tool of the Federal Reserve has been the federal funds rate. Because expectations of the future path of the funds rate play a central role in the term structure of interest rates and thus the monetary transmission mechanism, it is important to know how accurate these expectations are in predicting the funds rate. In this post, we investigate this issue using a well-known survey of private sector forecasters. We find that forecasts tend to over-predict the funds rate in easing cycles and under-predict it in tightening cycles. In addition, while forecasts ...
Working Paper
From Taylor's Rule to Bernanke's Temporary Price Level Targeting
Bernanke's strategies for integrating forward guidance into conventional instrument rules anticipate that effective lower bound (ELB) episodes may become part a regular occurrence and that monetary policy should recognize this likelihood (Bernanke (2017a); Bernanke (2017b)). Bernanke's first proposal is a form of flexible temporary price level targeting (TPLT), in which a lower-for-longer policy path is prescribed through a ?shadow rate?. This shadow rate accounts for cumulative shortfalls in inflation and output relative to exogenous trends, and the policy rate is kept at the ELB until the ...
Working Paper
Monetary Policy and Durable Goods
We analyze monetary policy in a New Keynesian model with durable and nondurable goods each with a separate degree of price rigidity. The model behavior is governed by two New Keynesian Phillips Curves. If durable goods are sufficiently long-lived we obtain an intriguing variant of the well-known ?divine coincidence.? In our model, the output gap depends only on inflation in the durable goods sector. We then analyze the optimal Taylor rule for this economy. If the monetary authority wants to stabilize the aggregate output gap, it places much more emphasis on stabilizing durable goods inflation ...
Working Paper
Hawkish or Dovish Fed? Estimating a Time-Varying Reaction Function of the Federal Open Market Committee's Median Participant
This paper estimates a time-varying reaction function of the median participant of the Federal Open Market Committee, using a Taylor rule with time-varying coefficients estimated on one- to three-year ahead median forecasts of the federal funds rate, inflation, and the unemployment rate from the Summary of Economic Projections (SEP). We estimate the model with Bayesian methods, incorporating the effective lower bound on the median federal funds rate projections. The results indicate that the monetary policy rule has become significantly more persistent after the pandemic than in the years ...
Working Paper
A New Look at Historical Monetary Policy and the Great Inflation through the Lens of a Persistence-Dependent Policy Rule
The origins of the Great Inflation, a central 20th century U.S. macroeconomic event, remain contested. Prominent explanations are poor forecasts or deficient activity gap estimates. An alternative view: the FOMC was unwilling to fight inflation, perhaps due to political pressures. Our findings, based on a novel approach, support the latter view. New econometric tools allow us to credibly identify the particular activity gap, if any, in use. Persistence-dependent unemployment (gap) responses in the 1970s were essentially the same pre- and post-Volcker. Conversely, FOMC behavior vis--vis ...