The Taylor Principle, Interest Rate Smoothing and Fed Policy in the 1970s and 1980s

Abstract

Using real time estimates of output gaps or Greenbook forecasts of the unemployment rate, this article estimates Taylor-type policy rules that predict the actual behavior of the funds rate during two sample periods, 1968Q1 to 1979Q2 and 1979Q3 to 1994Q4. The inflation rate response coefficient is close to unity over the first sub-period and well above unity over the second, suggesting Fed policy violated the Taylor principle during the first period. The adjustment of the funds rate in response to fundamentals is not as rapid during the first period as it is during the second. Together these results support the conventional view that the Fed was "too timid" and "too sluggish" during the late 1960s and the 1970s. Though the Fed smoothes interest rates, the degree of smoothing exhibited is far less than what was previously estimated. The funds rate response to its fundamentals is complete within one year during the first period and within one quarter during the second.

Term Structure Evidence on Interest Rate Smoothing and Monetary Policy Inertia

“…Lansing (2000) provides a careful simulation study that demonstrates the potential effectiveness of such real-time output gap errors to account for the spurious evidence of policy inertia in exactly this fashion. 34 Indeed, based on a reconstruction of real-time output gap data for the U.S., Mehra (2001) reports that the evidence for policy inertia and interest rate smoothing disappears when estimating partial adjustment rules using the real-time data. Real-time output gap revisions may not be a complete explanation because there are estimated reaction functions with signiÞcant inertia that do not include an output gap (for example, McNees, 1992, McCallum and Nelson, 1999, Fair, 2000, and the VAR interest rate equations); however, it seems likely that in general the real-time information set is an important element in accounting for spuriously inertial estimated policy rules.…”

Term Structure Evidence on Interest Rate Smoothing and Monetary Policy Inertia

“…Lansing (2000) provides a careful simulation study that demonstrates the potential effectiveness of such real-time output gap errors to account for the spurious evidence of policy inertia in exactly this fashion. 34 Indeed, based on a reconstruction of real-time output gap data for the U.S., Mehra (2001) reports that the evidence for policy inertia and interest rate smoothing disappears when estimating partial adjustment rules using the real-time data. Real-time output gap revisions may not be a complete explanation because there are estimated reaction functions with signiÞcant inertia that do not include an output gap (for example, McNees, 1992, McCallum and Nelson, 1999, Fair, 2000, and the VAR interest rate equations); however, it seems likely that in general the real-time information set is an important element in accounting for spuriously inertial estimated policy rules.…”

Monetary policy and prediction of variability

“…Kromě toho může dynamika vyhlášené hlavní úrokové sazby vykazovat odchylky od měnového pravidla (3) i v důsledku systematického vlivu dalších faktorů, jež jsou obecně prezentovány v podobě sériové korelace náhodných šoků w t (Rudebusch, 2002;English, Nelson a Sack, 2002;Mehra, 2002). Tím se poukazuje na to, že paleta zájmů centrální banky, které ovlivňují její rozhodování o změnách hlavní úrokové sazby, může být bohatší, než vyplývá z výše vymezené účelové funkce.…”