Hawkish or Dovish Fed? Estimating a Time-Varying Reaction Function of the Federal Open Market Committee's Median Participant

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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 prior, and it currently reacts strongly to inflation, at more than twice the responsiveness estimated prior to 2020. Our proposed policy rule produces accurate predictions of the median federal funds rate projections in real time for given SEP forecasts of inflation and the unemployment rate, suggesting that the median participant's reaction function is well-represented by our assumed Taylor rule with time-varying coefficients. Our results show that the median participant's reaction function becomes less persistent and less responsive to inflation yet more responsive to the output gap in anticipation of tighter monetary policy conditions. We also find that labor market activity, inflation, and macroeconomic uncertainty correlate significantly with the evolution of the time-varying coefficients of the rule. Finally, we show that in times of a less persistent policy rule or more responsiveness to inflation, markets perceive nominal bonds as better macroeconomic hedges.