Are central bank preferences asymmetric when policy targets vary over time?

Abstract

The purpose of this paper is to analyze the effect of time varying monetary policy targets on the asymmetric preferences hypothesis for US monetary policy. Recent literature suggests that monetary policy responds asymmetrically to fluctuations in either an output gap or unemployment gap. Most of these studies impose the assumption of constant inflation and interest rate targets. This paper models both of these target rates as time varying parameters using a nested specification to test for constancy in the target rates. Additionally, the paper examines the estimation strategy needed to estimate all of the policy maker’s structural or deep parameters for the asymmetric preferences model. The model is estimated via maximum likelihood using an iterative Kalman filter. Results show that asymmetric policy response over the output gap disappears for all sample periods when the joint underlying dynamics of inflation and interest rate data are accounted for. Additionally, the results indicate that policy target rates are not well represented by constants for all sample periods examined. As a whole, the empirical exercise suggests that conclusions about monetary policy behavior might be sensitive to modeling assumptions about target policy rates.