The Taylor Rule and 'Opportunistic' Monetary Policy

Abstract

We conduct a thorough statistical analysis of the empirical foundations for the existence of a Taylor rule. Inflation, the output gap and the federal funds rate appear to be non-stationary variables that are not cointegrated. Although this lack of cointegration could be caused by missing variables or structural breaks, we are unable to 'salvage' the rule using several plausible candidate variables and break dates. We also investigate the possibility that the Taylor rule should be modeled as a nonlinear relationship. We find that a simple threshold model makes significant progress towards rectifying some of the shortcomings of the standard model.

Assessing Nonlinear Dynamics of Central Bank Reaction Function: The Case of Mozambique

“…Contrarily to the MS, where the regimes are hidden, the TAR model separates the regimes based on threshold variables, which are observable variables by nature. This strategy is followed, for example, by Bunzel and Enders () who formulated a threshold process to model the Taylor rule that is consistent with an opportunistic monetary policy. Their version of the opportunistic model allows the monetary authorities to be policy active when the inflation is high relative to the interim threshold and when the output gap is negative.…”

“…Some contributions to research into nonlinear MPRFs in developed countries include Altavilla and Landolfo (), Assenmacher‐Wesche (2006), Cukierman and Muscatelli (), Bunzel and Enders (), among others. For instance, Altavilla and Landolfo (), assessed nonlinearities in MPRF in order to ascertain whether the European Central Bank (ECB) and the Bank of England have a different behaviour during recession and expansion.…”

“…Finally, they implemented a comparative analysis concerning the estimated rules as well as the different reactions of the real economy to monetary shocks and found evidence that the business cycle phase is an important matter in monetary policy‐making. Bunzel and Enders () investigated the possibility that the Taylor rule should be formulated as a threshold process which makes the Federal Reserve acts more aggressively in some circumstances than in others. They found that a modified threshold model that is consistent with “opportunistic” monetary policy makes significant progress towards explaining Federal Reserve behaviour.…”

The behaviour of the bank lending channel when interest rates approach the zero lower bound: Evidence from quantile regressions

“…The presence of asymmetries and nonlinearities in monetary policy specifications lead to very different empirical results. Cukierman and Muscatelli (2008) provide evidence in favour of the presence of nonlinearities in line with Fed's preferences towards inflation, while both Florio (2006) and Bunzel and Enders (2010) find asymmetric monetary policy reactions to policy interest rate changes. By contrast, Dolado et al (2005) find no evidence for nonlinearities associated with monetary policy decisions.…”

What Causes China's High Inflation? A Threshold Structural Vector Autoregression Analysis

“…The empirical evidence shows that a change in inflation dynamics is the most important source of a transition of the US economy from a high inflation state to a low inflation state, while a change in monetary policy reaction functions has very little effect. Bunzel and Enders (2010) also use the inflation threshold to estimate a nonlinear Taylor rule. Hwang and Wu (2011) find that there is an asymmetric and nonlinear relationship between inflation and economic growth in China; Liu and Pang (2011) point out that asymmetric effects exist between monetary policy and inflation.…”