The Taylor Rule, the Zero Lower Bound, and the Term Structure of Interest Rates

J. Huston McCulloch

A chapter in Monetary Policy in the Context of the Financial Crisis: New Challenges and Lessons, 2015, vol. 24, pp 405-417 from Emerald Group Publishing Limited

Abstract: The Taylor Rule’s Zero Lower Bound problem can be solved by pegging interest rates on longer-maturity loans than the 6 weeks implicit in the Fed’s current operating procedures. However, the Fed’s policy since 2008 of reducing the opportunity cost of excess reserves to zero (or even negative) has neutralized the stimulative effect of the Fed’s low interest rate policy. Eliminating interest on excess reserves would restore the effectiveness of monetary policy, but would require promptly unwinding the Fed’s “Quantatitve Easing” acquisitions. It is argued that the Fed’s reaction function should contain no pure inertial terms, and that the “output gap” as originally conceived by Taylor is a statistical illusion. Although the unemployment gap is statistically meaningful, it is not clear that it should be directly included in the Taylor Rule unless it serves as a proxy for the equilibrium real interest rate.

Keywords: Taylor Rule; Zero Lower Bound; term structure of interest rates; E52; E43; E58 (search for similar items in EconPapers)
Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:eme:isetez:s1571-038620150000024023

DOI: 10.1108/S1571-038620150000024023

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