Working Papers


The Taylor Principles


(with Alex Nikolsko-Rzhevskyy and Ruxandra Prodan),


We use tests for structural change to identify periods of low, positive, and negative Taylor rule deviations, the difference between the federal funds rate and the rate prescribed by the original Taylor rule. The tests define four monetary policy eras: a negative deviations era during the Great Inflation from 1965 to 1979, a positive deviations era during the Volcker disinflation from 1979 to 1987, a low deviations era during the Great Moderation from 1987 to 2000, and another negative deviations era from 2001 to 2014. We then estimate Taylor rules for the different eras. The most important violations of the Taylor principles, the four elements that comprise the Taylor rule, are that the coefficient on inflation was too low during the Great Inflation and that the coefficient on the output gap was too low during the Volcker disinflation. We then analyze deviations from several alterations of the original Taylor rule, which identify a negative deviations era from 2000 to 2007 and a low deviations era from 2007 to 2014. Between 2000 and 2007, Fed policy cannot be explained by any variant of the Taylor rule while, between 2007 and 2014, Fed policy is consistent with a rule where the federal funds rate does not respond at all to inflation and either responds very strongly to the output gap or incorporates a time-varying equilibrium real interest rate. (May 2015)


(Taylor) Rules versus Discretion in U.S. Monetary Policy


(with Alex Nikolsko-Rzhevskyy and Ruxandra Prodan)


The Taylor rule has been the dominant metric for monetary policy evaluation over the past 20 years, and it has become common practice to identify periods where policy either adheres closely to or deviates from the Taylor rule benchmark. The purpose of this paper is to identify (Taylor) rules-based and discretionary eras solely from the data so that knowledge of subsequent economic outcomes cannot influence the choice of the dates. We define Taylor rules-based and discretionary eras by smaller and larger Taylor rule deviations, the absolute value of the difference between the actual federal funds rate and the federal funds rate prescribed by the original Taylor rule, and use tests for multiple structural changes and Markov switching models to identify the eras. Monetary policy in the U.S. is characterized by a Taylor rules-based (low deviations) era until 1974, a discretionary (high deviations) era from 1974 to about 1985, a rules-based era from about 1985 to 2000, and a discretionary era from 2001 to 2013. The Taylor rule deviations are about three times as large in the discretionary eras than in the rules-based eras. The discretionary and rules-based eras closely correspond to periods where the Taylor rule deviations are above and below two percent. We calculate various loss functions and find that economic performance is uniformly better during (Taylor) rules-based eras than during discretionary eras. (January 2015)


Real-Time Historical Analysis of Monetary Policy Rules


(with Alex Nikolsko-Rzhevskyy)


The size of the output gap coefficient is the key determinant of whether quantitative easing since 2009 and continued near-zero interest rates can by justified by a Taylor rule. Fed Chair Ben Bernanke and Vice-Chair Janet Yellen have argued that John Taylor proposed a monetary policy rule with a larger output gap coefficient in his 1999 paper than in his 1993 paper, and have used this argument to justify negative prescribed interest rates in 2009-2010 and near-zero interest rates through 2015. While Taylor neither proposed nor advocated a different rule in 1999 than in 1993, he did not draw a distinction between the implications of the two rules. In accord with common practice at the time, Taylor used revised data. We show that, using real-time data available to policymakers (although not to Taylor when he wrote the paper), there is a sharp difference in the implications of rules with a smaller and a larger output gap coefficient. If John Taylor had been able to use real-time data in his 1999 paper, the importance of the distinction between Taylorís original rule with a smaller output gap coefficient and other rules with a larger coefficient would have been evident much earlier. (May 2013)







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