Policy Regime Changes, Judgment and Taylor rules in the Greenspan Era

Abstract

This paper investigates policy deviations from linear Taylor rules motivated by the risk management approach followed by the Fed during the Greenspan era. We estimate a nonlinear monetary policy rule via a logistic smoothing transition regression model where policy-makers' judgment, proxied by economically meaningful variables, drives the transition across policy regimes. We find that ignoring judgment‐induced nonlinearities while estimating Taylor rules has remarkable costs in terms of fit: above 250 bps in 10 quarters. Although linear Taylor rules describe well the broad contours of monetary policy, they fail to detect relevant policy decisions driven by policy‐makers' judgment.

Nonlinear Monetary Policy Rules: An Essay in the Comparative Study on Egyptian and Tunisian Central Banks

“…This is consistent with Bruggemann and Riedel (2011) [31] and Alcidi et al (2011) [32] identification of transition variable. They identify and use the lagged interest rate as a threshold variable.…”

The Relevance of International Spillovers and Asymmetric Effects in the Taylor Rule

“…Expansionary and contractionary monetary decisions might be based on a different set of determinants. In this vein, Alcidi et al (2009) show that linear Taylor rules fail to detect policy decisions driven by policymakers' judgment while smooth transition models are well-suited to improve linear Taylor reaction functions. This paper examines the causes for the deviations from the standard Taylor rule by analyzing the importance of both international spillovers and nonlinearities for monetary policy decisions in the main industrial countries, i.e.…”

An augmented Taylor rule for the Federal Reserve's response to asset prices

“…Several methods could be used to model nonlinear or asymmetric dynamics in the Taylor reaction function, based either on discontinuous regime switching models, like in the case of threshold or Markov switching models (e.g., Bec et al (2002), AssenmacherWesche (2006), Baxa et al (2013)), or on the class of continuous models, as in Smooth Transition Regression (STR) models (e.g., Castro (2011), Alcidi et al (2011), Brüggemann andRiedel (2011)). In particular, STR models suggested by Teräsvirta (1994) allows for smooth endogenous regime switches and are able to explain why and when the central bank changes its policy rule without any restrictions on the speed, intensity and persistence of the changes (Alcidi et al, 2011).…”