Wednesday, February 13, 2013

Tinkering with the Taylor

Pelin Ilbas, Øistein Røisland and Tommy Sveen think that the Fed, contrary to its namesake, was too Taylored to fit, during the early Bush Administration years;
We find that the model with the loss function that includes the original Taylor rule has a better empirical fit than the model with the standard loss function. Our result therefore confirms the indirect evidence in Kahn (2012) on the influence of the Taylor rule on the Federal Open Market Committee's policy decisions. Moreover, we find that the weight on the Taylor rule did not decrease in the period after 2003, contrary to what Taylor (2012) argues. When decomposing the various shocks hitting the US economy, we find that in the period 2001 - 2006, large negative demand-side shocks were dominating. As noted above, this is the type of disturbances that should make policymakers deviate from the Taylor rule. Indeed, the optimal policy response to these shocks implied an even lower interest rate than the actual Fed Funds Rate. We thus find that in the period 2001 - 2006 the Fed conducted a more contractionary policy than what would be implied by their historical reaction pattern.
That's baseball!

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