Working Paper: NBER ID: w1379
Authors: Joe Peek; James A. Wilcox
Abstract: This study investigates whether the apparent intertemporal instability of a particular reduced-form equation (that for interest rates) can be explained by changing government policy parameters, or regimes, and otherwise stable structural parameters. We hypothesize that major fiscal, monetary, and regulatory policy parameter shifts have been important sources of that instability. Direct tests imply that reduced-form coefficients move by statistically significant and economically meaningful amounts in response to policy parameter change. Allowing for this systematic parameter variation produces greater stability in the remaining parameters. Furthermore, in-sample and out-of-sample forecasts from the proposed model out perform those from the non-responsive parameter specification.
Keywords: Interest Rates; Policy Parameters; Reduced-Form Models
JEL Codes: E43; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Changes in fiscal, monetary, and regulatory policies (E63) | Intertemporal instability of reduced-form coefficients (C22) |
| Changes in personal tax rates (H29) | Response of nominal interest rates to anticipated inflation (E43) |
| Monetary policy adjustments (like the 1979 change in monetary policy) (E65) | Response of nominal interest rates to anticipated inflation (E43) |
| Regulatory innovations (such as the introduction of negotiable certificates of deposit) (G18) | Response of nominal interest rates to anticipated inflation (E43) |
| Allowing for varying policy parameters (C54) | Explanatory power of the model (C20) |
| Changes in fiscal, monetary, and regulatory policies (E63) | Changes in reduced-form coefficients (C22) |