Interest-Rate Rules in an Estimated Sticky Price Model

Abstract

This paper seeks to evaluate monetary policy rules that generalize the rule proposed by Taylor (1993). In particular, we consider rules in which the Fed sets the federal funds rate as a function of the history of inflation, output, and the federal funds rate itself. Even though this is not part of Taylor's original formulation, we introduce the possibility that the federal funds rate depends on the history of the funds rate itself in order to allow for interest rate smooth-ing of the kind that appears to be an important feature of current Fed policy. We also consider the character of optimal policy, that is, the policy that maxi-mizes the utility of the representative agent, assuming unlimited information about the exogenous disturbances to the economy. We then compare optimal policy in this unrestricted sense with the best rule of the generalized Taylor family. We evaluate these rules under the assumption that interest rate, inflation, and output determination in the U.S. economy can be compactly represented by the small structural model whose parameters we estimate in Rotemberg and

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