Articlegreen2008

The Taylor Rule: A Spurious Regression?*

69 citations0/0 files storedBulletin of Economic Research

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Monetary Policy and Economic Impact Forecasting Techniques and Applications Economic theories and models

Abstract

This paper investigates the econometric properties of the Taylor (1993) rule applied to US, Australian and Swedish data to judge its empirical relevance. Unit root tests indicate that the variables in the Taylor rule are near integrated processes, implying that cointegration is a necessary condition both for consistent estimation of the parameters of the model and compatibility between the model and the data. Tests find little support for cointegration and, together with an out-of-sample forecast exercise, suggest that we should have serious doubts about the Taylor rule as a reasonable description of how monetary policy is presently conducted. Parameters in Taylor rule regressions are therefore likely to be inconsistently estimated, and caution should be taken before central bank policy is evaluated using such methods.

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References

1987Co-Integration and Error Correction: Representation, Estimation, and Testing 1988Statistical analysis of cointegration vectors 1992Testing the null hypothesis of stationarity against the alternative of a unit root 1991Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models 1993Discretion versus policy rules in practice 1994Comparing Predictive Accuracy 1995Comparing Predictive Accuracy 2000Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory*

Cited by

2006Interest rate reaction functions for the euro area 2010‘Ex-ante’ Taylor rules – Newly discovered evidence from the G7 countries 2011Inflation targeting makes the difference: Novel evidence on inflation stabilization 2009Monetary Policy Rules and Inflation Process in Open Emerging Economies: Evidence for 12 New EU Members 2012Preference heterogeneity in the CEE inflation-targeting countries 2013Meta T aylor Rules for the UK and A ustralia; Accommodating Regime Uncertainty in Monetary Policy Analysis Using Model Averaging Methods

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