Taylor-type Interest Rate Rule Research Articles

Monetary Policy Under Steindlian Mark-up Dynamics

ABSTRACT We formulate a macrodynamic model of interaction between a post-Keynesian investment function with endogenous capacity utilization and pro-cyclical mark-up over wage costs in a demand-constrained closed economy. The main objective of the study is to examine whether, in the absence of effective collective bargaining by the workers, monetary policy can resolve class conflict and maintain social stability. We consider a modified version of the counter-cyclical Taylor-type interest-rate rules that targets income distribution through the rate of capacity utilization. We explore the extent to which a combination of pro-cyclical mark-up dynamics and counter-cyclical interest-rate rules can stabilize potentially unstable investment dynamics. We also examine the effectiveness of monetary policy in the form of interest-rate rules in stabilizing output and income distribution.

A NOTE ON SIMPLE MONETARY POLICY RULES WITH LABOR MARKET AND FINANCIAL FRICTIONS

We consider a New-Keynesian model with financial and labor market frictions where firms borrowing is limited by the enforcement constraint. The wage is set in a bargaining process where the firm's shareholder and worker share the production surplus. As debt service is considered to be a part of production costs, firms borrow to reduce the surplus which allows to lower the wage. We study the model's response to financial shock under two Taylor-type interest rate rules: first one responds to inflation and borrowing, second one to inflation and unemployment. We have found that the second rule delivers better policy in terms of the welfare measure. Additionally, we show that the feedback on unemployment in this rule depends on the extent of workers' bargaining power.

Did the Bundesbank react to the US dollar exchange rate?

This study explores monetary policy conduct by the German Central Bank just after switching to floating exchange rates and before adopting the European single currency. With the world economy going through the ‘great inflation’ first, and the ‘great moderation’ then, the focus is on the DM/US dollar exchange rate, as a proxy of external constraints. A Taylor-type interest rate rule with a sufficiently high inflation coefficient emerges as an equilibrium relation in a Vector Error Correction model, and operates as a reaction function. The exchange rate enters significantly and the dynamics generated are consistent with the derived rule and the macroeconomic theory. Hence, I argue that the Bundesbank kept an eye on the exchange rate and remained devoted to the long-standing policy of price stability.

Financial shocks, financial stability, and optimal Taylor rules

We assess the performance of optimal Taylor-type interest rate rules, with and without reaction to financial variables, in stabilizing an economy following financial shocks. The analysis is conducted in a DSGE model with loan and bond markets, each featuring financial frictions. This allows for a wide set of financial shocks and transmission mechanisms and can be calibrated to match the bond-to-bank finance ratio featured in the US financial system. Overall, we find that monetary policy that reacts to credit growth, a form of the so-called “leaning against the wind”, improves the ability of the central bank to achieve its mandate in the wake of financial shocks. The specific policy implications depend partly on the origin and the persistence of the financial shock, but overall not on the assignment of a mandate for financial stability in the central bank’s objective function.

On the choice of monetary policy rules for China: A Bayesian DSGE approach

Motivated by the institutional features of China's monetary policy, this paper aims at identifying the most data favored monetary policy rule for China within a dynamic stochastic general equilibrium (DSGE) model framework. In a canonical New-Keynesian DSGE model, we carry out a positive analysis by employing Bayesian methods to estimate three main categories of monetary policy rules, namely a Taylor-type interest rate rule, a money growth rule and an expanded Taylor rule with money. Based on China's quarterly data from 1996Q2 to 2015Q4, our estimation shows that the expanded Taylor rule obtains the best empirical fit to the data. Moreover, impulse responses and forecast error variance decompositions demonstrate that monetary policy rules with or without money provide very different implications for the policy behavior. Our results ultimately suggest that money has so far been more closely targeted than nominal interest rate and still plays an important role as a monetary policy target in China. Furthermore, a conventional Taylor-type interest rate rule is not good enough yet to describe China's monetary policy behavior.

News shocks, nonseparable preferences, and optimal monetary policy

Extending and modifying the canonical New Keynesian (NK) model by embedding a nonseparable Jaimovich/Rebelo (2009)-type utility function, this study provides a novel approach to examine the impact of anticipated shocks, called “news shocks”, on business cycles. It can be shown that news shocks cause larger economic fluctuations than unanticipated shocks of the same form and thus behave in a welfare-reducing manner. Given this, the paper explores how (optimal) monetary policy should be conducted. In line with earlier studies, the investigation of several Taylor-type interest rate rules shows that the lowest welfare losses can be achieved based on rules that respond to both contemporaneous and expected future macroeconomic conditions.

Identification-Robust Estimates of the Canadian Natural Rate of Interest

The natural rate of interest is an unobservable entity and its measurement presents some important empirical challenges. In this paper, we use identification-robust methods and central bank real-time staff projections to obtain estimates for the equilibrium real rate from contemporaneous and forward-looking Taylor-type interest rate rules. The methods notably account for the potential presence of endogeneity, under-identification, and errors-in-variables concerns. Our applications are conducted on Canadian data. The results reveal some important identification difficulties associated with some of our models, reinforcing the need to use identification-robust methods to estimate such policy functions. Despite these challenges, we are able to obtain fairly comparable point estimates for the real equilibrium interest rate across our different models, and in the case of the best fitting model, also remarkable estimate precision.

Assessing the Monetary Policy Stance in Turkey Using the Natural Interest Rate

This study assesses the monetary policy stance in Turkey using the natural interest rate. In doing so, the study utilizes an empirical framework that estimates the natural interest rate as an unobserved stochastic variable using a parsimonious new Keynesian model consisting of a Phillips curve, an IS curve and a backward-looking Taylor-type interest rate rule. In addition, the model includes stochastic laws of motion for natural interest rate and potential output. Given the dynamic nature of the Turkish economy, the parameters are assumed to be time-varying. This introduces nonlinearity to the system, which can be handled by the Extended Kalman Filter (EKF) algorithm. The analysis results suggest that the estimated natural interest rate is informative about the monetary policy stance. This is especially true after 2010, which is marked by the CBRT’s (Central Bank of the Republic of Turkey) adoption of the new monetary policy mix. The study also addresses the zero lower bound issue, which has dominated the advanced economies after the global crisis. But most importantly, this study underlines the need to find an accurate measure for assessing the monetary policy stance to meet the challenges induced by the post-crisis period.

Financial Shocks and Optimal Monetary Policy Rules

We assess the performance of optimal Taylor-type interest rate rules, with and without reaction to financial variables, in stabilizing the macroeconomy following financial shocks. We use a DSGE model that comprises both a loan and a bond market, which best suits the contemporary structure of the U.S. financial system and allows for a wide set of financial shocks and transmission mechanisms. Overall, we find that targeting financial stability ‐ in particular credit growth, but in some cases also financial spreads and asset prices ‐ improves macroeconomic stabilization. The specific policy implications depend on the policy regime, and on the origin and the persistence of the financial shock.

Assessing the Impacts of Non-Ricardian Households in an Estimated New Keynesian DSGE Model

SummaryA New Keynesian DSGE model with non-Ricardian households is estimated for the Portuguese economy and the stability of the model’s prediction (posterior distributions, impulse responses, and sources of fluctuations in endogenous variables) tested under different assumptions on non-Ricardian households. Their share is estimated to be relatively high (58 %). Furthermore, estimates of several parameters as well as the magnitude and persistence of shocks are particularly sensitive to the share of non-Ricardian households. Impulse responses to consumption preference and productivity shocks are amplified for lower shares; for greater proportions, the model predicts more noticeable responses to price markup and government spending shocks. Fluctuations in output growth are mainly driven by productivity shocks for a lower share and by price markup shocks in the opposite scenario. A high proportion of these households together with a high degree of price stickiness lead the Taylor-type interest rate rule solution to be locally indeterminate.

Financial Shocks, Financial Stability, and Optimal Taylor Rules

We assess the performance of optimal Taylor-type interest rate rules, with and without reaction to financial variables, in stabilizing an economy following financial shocks. The analysis is conducted in a DSGE model with loan and bond markets, each featuring financial frictions. This allows for a wide set of financial shocks and transmission mechanisms and can be calibrated to match the bond-to-bank finance ratio featured in the US financial system. Overall, we find that monetary policy that reacts to credit growth, a form of the so-called “leaning against the wind”, improves the ability of the central bank to achieve its mandate in the wake of financial shocks. The specific policy implications depend partly on the origin and the persistence of the financial shock, but overall not on the assignment of a mandate for financial stability in the central bank’s objective function.

Is Globalization Weakening the Inflation-Output Relationship?

This paper investigates whether trade and financial openness has weakened the inflation–output trade-off and caused a shift in the preferences of monetary authorities. Based on the backward-looking Phillips curve and a Taylor-type interest rate rule, our results for France, the UK and the USA for the 1970–2012 period do not provide support for the relevance of globalization in making inflation less responsive to output expansions. Moreover, the change of preferences of Central Banks towards growth-oriented objectives is neither due to higher trade nor to financial globalization. (This abstract was borrowed from another version of this item.)

Oil Price Shocks and Macroeconomy: The Role for Precautionary Demand and Storage

Traditional literature on energy economics gives a central role to exogenous political events (supply shocks) or to global economic growth (aggregate demand shock) in modeling the oil market. However, more recent literature claims that the increased precautionary demand for oil triggered by increased uncertainty about a future oil supply shortfall is also driving the price of oil. The intuition behind the precautionary demand is that since firms, using oil as an input in their production process, are concerned about the future oil prices, it is reasonable to think that in the case of uncertainty about future oil supply (such as a highly expected war in the Middle East), they will buy futures and/or forward contracts to guarantee a future price and quantity. We find that under baseline Taylor-type interest rate rule, real oil price, inflation and output loss overshoot and go down below steady state at the next period if uncertainties are not realized. However, if the shock is realized, i.e. followed by an actual supply shock, the effect on inflation and output loss is high and persistent.

Shifting Preferences at the Fed: Evidence from Rolling Dynamic Multipliers and Impulse Response Analysis

The existing empirical literature on Taylor-type interest rate rules has failed to achieve a robust consensus. Indeed, the relatively common finding that the Taylor principle does not hold has fueled a degree of controversy in the field. We attribute these mixed estimation results to a raft of empirical issues from which many existing studies suffer, including bias, inconsistency, endogeneity and a failure to adequately account for the combination of persistent and stationary variables. We propose a new method of combining I(0) and I(1) series in a system setting based on the long-run structural approach of Garratt, Lee, Pesaran and Shin (2006). The application of this method to a long sample of US data provides modest support for the operation of a Taylor-type rule, albeit with considerable inertia. We argue that estimation across rolling windows may better reflect shifts in the underlying preferences of the monetary policymakers at the Federal Reserve. Such rolling estimation provides substantial evidence that the inflation and output preferences of the Fed have varied through time, presumably reflecting the prevailing economic and political conditions, its chairmanship, and the composition of the Federal Open Market Committee. Our most significant finding is that the Taylor Principle was robustly upheld under Volcker, often upheld pre-Volcker but rarely observed post-Volcker over any horizon.

Global and local determinacy in a one-step forward looking New Keynesian model

In this paper we consider a New Keynesian model for optimal monetary policy in a staggered fashion. We provide the relations of a non linear model of general economic equilibrium, implementing a suitable Taylor-type interest rate rule. We characterize the conditions that guarantee local determinacy and explore conditions under which local bifurcations of the target equilibrium may occur. Afterwards, we argue how local determinacy might be associated with global indeterminacy, providing some numerical examples.

A view on post-Keynesian interest rate policy

The dominant role of the »new consensus models« in central banks' policy-making in the last two decades has triggered the reaction of post-Keynesian economists to examine alternatives to inflation-targeting monetary strategies and to Taylor-type interest rate rules. This paper develops a simple macroeconomic model in order to pinpoint the distributional/demand effects of rentiers' interest income in a money/debt-using and demand determined economy. The ultimate objective of this model is to provide a starting point for the development of a post-Keynesian approach to interest rate policy that differs from the »activist« and the »parking-it« approaches.

Monetary Policy in Vietnam: Evidence from a Structural VAR

This paper characterizes the monetary policy rules used by the State Bank of Vietnam in the post-1992 period. Rather than following a Taylor-type interest-rate rule, the SBV appears to have followed a McCallum rule, adjusting monetary growth in response to the price level, the exchange rate, and the difference between the world price of gold and the price of gold in Vietnam at the official exchange rate. When this policy-rule is incorporated into a structural vector-autoregression (SVAR), shocks to the gold-price gap are also found to be valuable for explaining changes in the domestic price level and exchange rate. Thus, given Vietnam's unique institutional, cultural and historical circumstances, the gold price gap has been a valuable indicator for the successful implementation of monetary and exchange rate policies.

INCREASING RETURNS AND THE DESIGN OF INTEREST RATE RULES

We introduce increasing returns to scale into an otherwise standard New Keynesian model with capital, and study the determinacy and E-stability of equilibrium under Taylor-type interest rate rules. With very mild increasing returns supported by empirical research, the conventional wisdom regarding the design of interest rate rules can be overturned. In particular, the “Taylor principle” no longer guarantees either determinacy or E-stability of the rational expectations equilibrium.

Bayesian estimation and evaluation of the segmented markets friction in equilibrium monetary models

This paper develops, estimates and evaluates a heterogeneous agents segmented markets model with endogenous production and a monetary authority that follows a Taylor-type interest rate rule. We find that adding the segmented markets friction significantly improves the statistical out-of-sample prediction performance of the model, and helps generate delayed and realistic impulse response functions to monetary policy shocks. The estimated segmented markets model also outperforms the standard limited participation model, both in terms of marginal likelihood and of qualitative features of the impulse response function. We estimate the fraction of households participating in financial markets to be approximately 22%.

Optimal interest rate rules, asset prices, and credit frictions

We study optimal Taylor-type interest rate rules in an economy with credit market imperfections. Our analysis builds on the agency cost framework of Carlstrom and Fuerst [1997. Agency costs, net worth and business fluctuations: a computable general equilibrium analysis. American Economic Review 87, 893–910], which we extend in two directions. First, we embed monopolistic competition and sticky prices. Second, we modify the stochastic structure of the model in order to generate a countercyclical premium on external finance. This is achieved by linking the mean distribution of investment opportunities faced by entrepreneurs to aggregate total factor productivity. We model monetary policy in terms of simple welfare-maximizing interest rate rules. We find that monetary policy should respond to increases in asset prices by lowering interest rates. However, when monetary policy responds strongly to inflation, the marginal welfare gain of responding to asset prices vanishes. Within the class of linear interest rate rules that we analyze, a strong anti-inflationary stance always attains the highest level of welfare.