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Monetary Policy Rules

Empirical Applications Based on Survey Data

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Dirk Bleich

This work provides different studies of how econometric evaluation of monetary policy based on forward-looking Taylor rules is conducted. The first part discusses theoretical results regarding the Taylor principle and can be used as a guideline for the evaluation of the following three empirical applications based on survey data of Consensus Economics. The first application deals with the question whether the introduction of inflation targeting affects monetary policy. The second application investigates the consequences of oil price movements for monetary policy. The third application analyzes monetary policy conditions in Spain before and after the changeover to the Euro by estimating forward-looking Taylor rules.

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Chapter 2 Stability conditions for forward-looking monetary policyrules in the basic New Keynesian model

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Chapter 2 Stability conditions for forward-looking monetary policy rules in the basic New Keynesian model 2.1 Introduction Since the seminal paper of Taylor (1993) it has virtually become a convention to describe the interest rate setting behavior of central banks in terms of monetary policy reaction functions. In its plain form, the so-called Taylor rule states that the short-term interest rate, i.e., the instrument of a central bank, reacts to deviations of inflation and output from their respective target levels. For the purpose of econometric analysis the original Taylor rule has been modified in several ways. One important modification is the usage of forward-looking instead of contemporaneous data. The theoretical justification for this is that monetary policy works with a lag and, thus, effective monetary policy should focus on forecast values of the goal variables, rather than the current values. Among others, Clarida et al. (1998) and Taylor (1999) show that central banks in deed act in a forward-looking manner. For evaluation of monetary policy, it is of particular importance how the interest rate reacts to deviations of the inflation rate from its target level. In order to act in a stabilizing manner the central bank has to react with its nominal policy rate more than proportional to underlying inflation shocks. 20 Chapter 2. Stability conditions This will result in an increase of the real interest rate.1 Such an inflation stabilizing policy is often referred to as the well known Taylor principle....

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