Empirical Applications Based on Survey Data
Chapter 2 Stability conditions for forward-looking monetary policyrules in the basic New Keynesian model
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....
You are not authenticated to view the full text of this chapter or article.
This site requires a subscription or purchase to access the full text of books or journals.
Do you have any questions? Contact us.Or login to access all content.