Optimal Taylor Rules in New Keynesian Models

Christoph Boehm and Christopher L. House

No 20237, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We analyze the optimal Taylor rule in a standard New Keynesian model. If the central bank can observe the output gap and the inflation rate without error, then it is typically optimal to respond infinitely strongly to observed deviations from the central bank's targets. If it observes inflation and the output gap with error, the central bank will temper its responses to observed deviations so as not to impart unnecessary volatility to the economy. If the Taylor rule is expressed in terms of estimated output and inflation then it is optimal to respond infinitely strongly to estimated deviations from the targets. Because filtered estimates are based on current and past observations, such Taylor rules appear to have an interest smoothing component. Under such a Taylor rule, if the central bank is behaving optimally, the estimates of inflation and the output gap should be perfectly negatively correlated. In the data, inflation and the output gap are weakly correlated, suggesting that the central bank is systematically underreacting to its estimates of inflation and the output gap.

JEL-codes: E3 E31 E4 E43 E5 E52 E58 (search for similar items in EconPapers)
Date: 2014-06
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Note: EFG ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

Downloads: (external link)
http://www.nber.org/papers/w20237.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:20237

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w20237

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().