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Can a Taylor rule better explain the Fed’s monetary policy through the 1920s and 1930s ? A nonlinear cliometric analysis

Olivier Damette, Fredj Jawadi () and Antoine Parent ()

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Abstract: This paper investigates whether a variant of a Taylor rule applied to historical monetary data of the interwar period is useful to gain a better understanding of the Fed's conduct of monetary policy over the period 1920–1940. To this end, we considered a standard Taylor rule (using two drivers: output gap and inflation gap) and proxied them differently for robustness. Further, we extended this Taylor rule to a nonlinear framework while enabling its coefficient to be time-varying and to change with regard to the phases in business cycle, in order to better capture any further asymmetry in the data and the structural break induced by the Great Depression. Accordingly, we showed two important findings. First, the linearity hypothesis was rejected, and we found that an On/Off Taylor Rule is appropriate to reproduce the conduct of monetary policy during the interwar period more effectively (the activation of drivers only occurs per regime). Second, unlike Field [Field, A. 2015. "The Taylor Rule in the 1920s." Working Paper], we validated the use of a Taylor rule to explain the conduct of monetary policy in history more effectively. Consequently, this nonlinear Taylor rule specification provides interesting results for a better understanding of monetary regimes during the interwar period, and offers useful complements to narrative monetary history.

Keywords: Taylor rules; Threshold models; Monetary cliometrics; Monetary policy; Nonlinearity (search for similar items in EconPapers)
Date: 2018-12-19
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Published in Studies in Nonlinear Dynamics and Econometrics, MIT Press, 2018, 22 (5), pp.20170107. ⟨10.1515/snde-2017-0107⟩

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DOI: 10.1515/snde-2017-0107

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