Taylor Rules and Interest Rate Smoothing in the Euro Area

Manchester School (Impact Factor: 0.26). 02/2007; 75(1):1-16. DOI: 10.1111/j.1467-9957.2007.01000.x
Source: RePEc


Conventional wisdom suggests that central banks implement monetary policy in a gradual fashion. Some researchers claim that this gradualism is due to 'optimal cautiousness'; in contrast, Rudebusch (Journal of Monetary Economics, Vol. 49 (2002), pp. 1161-1187) states that the observed policy rate sluggishness is mainly due to serially correlated exogenous shocks. In this paper we use models in first differences to assess the 'endogenous' versus 'exogenous' gradualism hypothesis for the Euro area. Our results suggest that the joint formalization of the two hypotheses is likely to offer the best simple approximation of the Euro area monetary policy conduct. Copyright © 2007 The Author; Journal compilation © 2007 Blackwell Publishing Ltd and The University of Manchester.

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Available from: Efrem Castelnuovo, Oct 30, 2014
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    • "This result again is also robust to different specifications of the Taylor rule in equation (1) or to different measures for inflation and the output gap. However, Castelnuovo (2007) emphasizes that the rejection of the null hypothesis does not imply that there is no role for serially correlated shocks. He, therefore, concludes that the data may support both points of view. "
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    ABSTRACT: Against the background of the recent discussion whether the smoothing behavior of the Fed detected by empirical Taylor rules is indeed a fact or rather a statistically fiction, this paper re-examines the empirical evidence for interest rate smoothing for the case of the ECB. Based on data representing true ECB behavior, our findings reject the hypothesis of no smoothing but also find a role of serially correlated shocks. The degree of smoothing is estimated in the range of [0:40;0:82], reflecting model uncertainty with respect to the output gap and indicating a rather moderate extent of partial adjustment. Moreover, we find a significant reaction to the output gap. In contrast, the reaction coefficient for current inflation is insignificant, while it is highly significant for the one-year-ahead forecast of the ECB’s Survey of Professional Forecasters.
    Preview · Article · Jun 2011 · SSRN Electronic Journal
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    • "The estimate of θ is also significantly larger than zero. These results are consistent with those obtained by English, Nelson and Sack (2003), Gerlach-Kristen (2004) and Castelnuovo (2007), who insist that the joint formalization of the two hypotheses will be the best approximation to policy rules. However, Figure 10 indicates that the estimate of θ will no longer be significantly different from zero if the desired rate is sufficiently persistent, while the significance of φ i will still be maintained. "
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    ABSTRACT: Many empirical studies argue that the inertial behavior of the policy rates in industrialized countries can be well explained by a linear partial adjustment version of the Taylor rule. However, the explanatory power of the lagged interest rate has been questioned from various points of view. This paper formally examines a situation in which a central bank has an aversion for frequent policy reversals. Imposing an irreversibility constraint on the control space makes the lagged interest rate a state variable, but the policy function cannot then be expressed as a partial adjustment form even if the original Taylor rule is the correct policy function in the absence of the constraint. The simulation results reveal that the conventional regression tends to falsely support the functionally misspecified partial adjustment model. This implies that the significant role of the lagged interest may simply reflect the central banks’ reversal aversion.
    Full-text · Article · Jan 2010 · The B E Journal of Macroeconomics
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    • "One outstanding empirical feature of estimated instruments rule is the high degree of monetary policy gradualism, as measured by the persistence of policy rates and their slow adjustment to the equilibrium values determined by the monetary policy targets. This evidence of very strong persistence was first found in US data ( see Clarida et al.(2000)) and similar results have been subsequently obtained on Euro area data (Castelnuovo(2007)). Rudebusch(2002) and Soderlind et al.(2005) have argued that the degree of policy inertia delivered by the estimation of Taylor-type rules is heavily upward biased. "
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    ABSTRACT: Empirical estimates of monetary policy reaction functions feature a very high estimated degree of monetary policy inertia. This evidence is very hard of reconcile with the alternative evidence of low predictability of monetary policy rates. In this paper we examine the potential relevance of the problem of weak instruments to correctly identify the degree of monetary policy inertia in forward-looking monetary policy reaction function of the type originally proposed by Taylor [1993. Discretion versus policy rules in practice. Canergie-Rochester Conference Series on Public Policy, 39, 195–214]. After appropriately diagnosing and taking care of the weak instruments problem, we find an estimated degree of policy inertia which is significantly lower than the common value in the empirical literature on monetary policy rules.
    Full-text · Article · Jun 2009 · Journal of Monetary Economics
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