Working Papers


Taylorís Rule versus Taylor Rules


(with Alex Nikolsko-Rzhevskyy)


Does the Taylor rule prescribe negative interest rates for 2009-2011? This question is important because negative prescribed interest rates provide a justification for quantitative easing once actual policy rates hit the zero lower bound. We answer the question by analyzing Fed policy following the recessions of the early-to-mid 1970s, the early 1990s, and the early 2000s in the context of both Taylorís original rule and latter variants of Taylor rules. While Taylorís original rule, which can be justified by historical experience during and following the recessions, does not produce negative prescribed interest rates for 2009-2011, variants of Taylor rules with larger output gap coefficients, which do produce negative interest rates, cannot be justified by the same historical experience. We conclude that the Taylor rule does not provide a rationale for quantitative easing. Forthcoming: International Finance


Markov Switching and the Taylor Principle


(with Chris Murray and Alex Nikolsko-Rzhevskyy)


Early research on the Taylor rule typically divided the data exogenously into pre-Volcker and Volcker-Greenspan subsamples.We contribute to the recent trend of endogenizing changes in monetary policy by estimating a real-time forward-looking Taylor rule with endogenous Markov switching coefficients and variance. The response of the interest rate to inflation is regime dependent, with the pre and post-Volcker samples containing monetary regimes where the Fed did and did not follow the Taylor principle. While the Fed consistently adhered to the Taylor principle before 1973 and after 1984, it followed the Taylor principle from 1975-1979 and did not follow the Taylor principle from 1980-1984.We also find that the Fed only responded to real economic activity during the states in which the Taylor principle held.Our results are consistent with the idea that exogenously dividing postwar monetary policy into pre-Volcker and post-Volcker samples misleading. The greatest qualitative difference between our results and recent research employing time varying parameters is that we find that the Fed did not adhere to the Taylor Principle during most of Paul Volckerís tenure, a finding which accords with the historical record of monetary policy. Forthcoming, Macroeconomic Dynamics


Time Series Tests of Constant Steady-State Growth


(with Ruxandra Prodan)


We propose a new methodology to study the stability of steady-state growth. Long-run GDP per capita can be characterized by: (1) the linear trend hypothesis, where there are no long-run changes in GDP levels or growth rates, (2) the level shift hypothesis, where there are long-run level shifts, but not changes in growth rates, and (3) the growth shift hypothesis, where there are long-run changes in both GDP levels and growth rates. We formally test these hypotheses using time series techniques with over 135 years of data. The results are not favorable to the hypothesis of constant steady-state growth. While we find evidence supporting the linear trend hypothesis for the United States and Canada and the level shift hypothesis for three additional OECD countries, the growth shift hypothesis is supported for seven OECD and four Asian countries. The results are not driven by transition dynamics. (August 2012)



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)


(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 2008. The Taylor rule deviations are about three times as large in the discretionary eras than in the rules-based eras and are almost four times larger in the most discretionary era (1974 to 1984) than in the least discretionary era (1985 to 2000). With the Markov switching models, which allow for regime changes at the beginning and end of the sample, we also identify a discretionary era from 1965 to 1968 and a rules-based era in 2006 and 2007. The discretionary and rules-based eras closely correspond to periods where the Taylor rule deviations are above and below two percent. (July 2013)








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