Taylor Rule or optimal timeless policy? Reconsidering the Fed's behavior since 1982

We compare three standard New Keynesian models differing only in their representations of monetary policy—the Optimal Timeless Rule, the original Taylor Rule and another with ‘interest rate smoothing’—with the aim of testing which if any can match the data according to the method of indirect inferen...

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Bibliographic Details
Published in:Economic modelling 2013-05, Vol.32, p.113-123
Main Authors: Minford, Patrick, Ou, Zhirong
Format: Article
Language:English
Subjects:
Economic models
Economic theory
Identification
Indirect inference
Interest rates
Keynesian theory
Keynesianism
Mathematical models
Monetary policy
Optimal Timeless Rule
Parameter estimation
Statistical inference
Studies
Taylor rule
Taylor Rules
Wald statistic
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Summary:We compare three standard New Keynesian models differing only in their representations of monetary policy—the Optimal Timeless Rule, the original Taylor Rule and another with ‘interest rate smoothing’—with the aim of testing which if any can match the data according to the method of indirect inference. We find that the Optimal Timeless Rule performs the best, either with calibrated parameters or with estimated parameters. This model can also account for the widespread finding of apparent ‘Taylor Rules’ and smoothed interest rates in the data, even though neither of these represents the true policy. ► We uncover the Fed's behavior since 1982 by comparing fully identified models. ► The Fed's behavior over this period was shown to optimize social welfare. ► But this can be confused with an ‘interest-rate-smoothed’ Taylor Rule. ► The latter, while being able to mimic the former, is a statistical artifact.
ISSN:0264-9993
1873-6122
DOI:10.1016/j.econmod.2013.01.029