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A Discussion of the Taylor Rule

  • Economics


BANK08UJL3 81 A Discussion of the Taylor Rule By David Doran and Ro´na´n Hickey* Abstract Monetary policy rules have been advocated as a mechanism to increase the transparency, accountability and consistency of the monetary policy decision- making process. These rules range from simple unconditional to more complicated feedback rules. In the case of the latter the policy instrument is determined by developments in underlying factors. The most prominent example of a feedback rule is the Taylor rule, which provides a simple estimate of the appropriate stance of monetary policy given an economy’s inflation rate and the output gap. It can also be used ex-post in a descriptive capacity, providing an account of how a central bank has responded to economic developments in the past. There is much debate as to how a Taylor rule should be operationalised. Amongst other things, this reflects issues over the data included, the use of interest rate smoothing techniques and the correct values that should be placed on the coefficients in the rule. Reflecting these issues different Taylor rules produced for an individual economy can provide very different policy prescriptions. As a result, they should be interpreted with caution. Bearing this in mind, however, the paper reviews the recent changes in monetary policy in the major economies relative to the Taylor rule. *The authors are economists in the Monetary Policy & International Relations Department. The views expressed in this article are the personal responsibility of the authors and are not necessarily those held by the CBFSAI or the ESCB. The authors would like to thank Gerard O’Reilly, Maurice McGuire, Rafique Mottiar and Tom O’Connell for their comments and suggestions. A Discussion of the Taylor Rule Quarterly Bulletin 03 / July 0982 1. Introduction There has been much debate about the usefulness of policy rules in the setting of monetary policy. A monetary policy rule places a restriction on the discretionary policy options that poli

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