Some Problems with Taylor Rules
Some problems with Taylor rules
YUGUANG LIN 870311-T297
1 Taylor rule
Interest rates, inflation rate and real output have always been important factors for the government and its central bank to reexamine the formulation of macroeconomic policy. Their intrinsic links are also concerned issues for the economic circles. People generally believe that monetary policy should respond in a manner that the adjustment of the interest rate could timely reflect the inflation and real output changes, and effectively inhibit price from excessively change to be up or down, and can also help to promote healthy and stable macroeconomic growth. Then John Taylor (1993) proposed a "Taylor rule" is a simple monetary policy around Interest rates on the relationship between inflation and real output. The Taylor rule has become a good reference for central banks to make the actual monetary policy. Taylor rules assumes that the monetary authorities to use monetary policy tools to focus on two key objectives of the main function, inflation gap (the deviation between actual inflation rate and the inflation target level) and the output gap (the deviation between actual output and the potential output). But are Taylor rules good monetary policy? Here, “good monetary policy” should be defined as the conventional meaning of promoting the central bank to stabilize the inflation successfully around a low average level and also level off output with potential output, so called flexible inflation targeting. So what answer could be found in the various literature to supply? According to this
interpretation (Lars E. O. Svensson 2002), an instrument rule (a policy rule) expresses the central bank’s instrument as an explicit function of information available to the central bank. Most of the literature focuses on simple instrument rules, where the instrument is a function of lacking sufficient information available to the central bank. The well known simple instrument rule is the Taylor rule
YUGUANG LIN 870311-T297
1 Taylor rule
Interest rates, inflation rate and real output have always been important factors for the government and its central bank to reexamine the formulation of macroeconomic policy. Their intrinsic links are also concerned issues for the economic circles. People generally believe that monetary policy should respond in a manner that the adjustment of the interest rate could timely reflect the inflation and real output changes, and effectively inhibit price from excessively change to be up or down, and can also help to promote healthy and stable macroeconomic growth. Then John Taylor (1993) proposed a "Taylor rule" is a simple monetary policy around Interest rates on the relationship between inflation and real output. The Taylor rule has become a good reference for central banks to make the actual monetary policy. Taylor rules assumes that the monetary authorities to use monetary policy tools to focus on two key objectives of the main function, inflation gap (the deviation between actual inflation rate and the inflation target level) and the output gap (the deviation between actual output and the potential output). But are Taylor rules good monetary policy? Here, “good monetary policy” should be defined as the conventional meaning of promoting the central bank to stabilize the inflation successfully around a low average level and also level off output with potential output, so called flexible inflation targeting. So what answer could be found in the various literature to supply? According to this
interpretation (Lars E. O. Svensson 2002), an instrument rule (a policy rule) expresses the central bank’s instrument as an explicit function of information available to the central bank. Most of the literature focuses on simple instrument rules, where the instrument is a function of lacking sufficient information available to the central bank. The well known simple instrument rule is the Taylor rule
References: McCallum, B. T. (2009). "Inflation Determination with Taylor Rules: Is New-Keynesian Analysis Critically Flawed?" Journal of Monetary Economics 56 8:1101-1108. Svensson, L. E. O. (2003). "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules." Journal of Economic Literature 41 2:426-477. Svensson, L. E. O., A. Chrystal, et al. (2009). What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules. Recent Developments in Monetary Policy. Volume 1. Elgar Reference Collection. International Library of Critical Writings in Economics, vol. 235. Cheltenham, U.K. and Northampton, Mass..Elgar: 487-538. Carare, A. and R. Tchaidze (2005). The Use and Abuse of Taylor Rules: How Precisely Can We Estimate Them? International Monetary Fund, IMF Working Papers, 05/148: 30 pages. TAYLOR, J. (1998): “Monetary Policy Guidelines for Employment and Inflation Stability”, in R. SOLOW, J. TAYLOR, eds: Inflation, Unemployment and Monetary Policy, Cambridge (Mass.), MIT Press. Cochrane, J. H., 2007. Inflation Determination with Taylor Rules: A Critical Review. NBER Working Paper 13409.