Does the Federal Reserve Follow a Non-Linear Taylor Rule?

No 2007-37, Working papers from University of Connecticut, Department of Economics

Abstract: The Taylor rule has become one of the most studied strategies for monetary policy. Yet, little is known whether the Federal Reserve follows a non-linear Taylor rule. This paper employs the smooth transition regression model and asks the question: does the Federal Reserve change its policy-rule according to the level of inflation and/or the output gap? I find that the Federal Reserve does follow a non-linear Taylor rule and, more importantly, that the Federal Reserve followed a non-linear Taylor rule during the golden era of monetary policy, 1985-2005, and a linear Taylor rule throughout the dark age of monetary policy, 1960-1979. Thus, good monetary policy is associated with a non-linear Taylor rule: once inflation approaches a certain threshold, the Federal Reserve adjusts its policy-rule and begins to respond more forcefully to inflation.

Keywords: Taylor rule; Federal Reserve; non-linearity; monetary policy (search for similar items in EconPapers)
JEL-codes: E4 E5 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: Written 2007-09
Note: I would like to thank Christian Zimmermann (adviser), Paul Beaumont, Steve Cunningham, and Philip Shaw for many good conversations about monetary policy and time series econometrics.
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