Working Paper: CEPR ID: DP3405
Authors: Juan José Dolado; Ramón Marí Dolores; Francisco J. Rugemurcia
Abstract: This Paper derives optimal monetary policy rules in setups where certainty equivalence does not hold because either central bank preferences are not quadratic, and/or the aggregate supply relation is non-linear. Analytical results show that these features lead to sign and size asymmetries, and non-linearities in the policy rule. Reduced-form estimates indicate that US monetary policy can be characterized by a non-linear policy rule after 1983, but not before 1979. This finding is consistent with the view that the Fed?s inflation preferences during the Volcker-Greenspan regime differ considerably from the ones during the Burns-Miller regime.
Keywords: asymmetric preferences; inflation targets; monetary policy; nonlinear Phillips curve; nonlinear Taylor rules
JEL Codes: E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| US monetary policy before 1983 can be characterized by a linear policy rule (E61) | US monetary policy after 1983 can be characterized by a nonlinear policy rule (E65) |
| Inflation preferences of the Federal Reserve differ across the two periods (before 1983 and after 1983) (E31) | Asymmetry in inflation preferences during the Volcker-Greenspan regime (E31) |
| The response of the nominal interest rate to inflation and output gap deviations is influenced by the conditional variance of inflation (E31) | Central bank's reaction function is influenced by the conditional variance of inflation (E52) |
| The response of monetary policy to inflation and output gap deviations is not straightforward due to asymmetric preferences (E19) | Certainty equivalence does not hold (D81) |