The Taylor Principles

Abstract

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.