LOGO Can central bank’s monetary policy be described by a linear (augmented) Taylor rule or by a monetary rule? GVHD: GS.TS TRẦN NGỌC THƠ SVTH : NHÓM 12-K23 COMPANY LOGO www.themegallery.com SUMMARY Why study? 1 Literature reviews 4 Hypothesises and Prediction 3 Theories 2 Research methods 5 Conclusion 6 COMPANY LOGO www.themegallery.com Why study? Should central banks obey a linear (augmente) Taylor rule or nonlinear rule? a Need to modeling to test which rule the best is How to conduct monetary policy? COMPANY LOGO www.themegallery.com STUDY OBJECTIVES the roles of a forward- looking version of the Taylor rule in the conduct of monetary policy Objectives The role of asset prices or financial variables in the conduct of monetary policy Comparing a linear Taylor rule with a nonlinear rule COMPANY LOGO www.themegallery.com RESEARCH QUESTION  whether central banks’ monetary policy can indeed be described by a linear Taylor rule or, instead, by a nonlinear rule?  whether that rule can be augmented with a financial conditions index containing information from some asset prices and financial variables? COMPANY LOGO www.themegallery.com Theories Taylor rule Monetary policy Rational Expectation Forward looking Taylor rule Asset prices vs Financial variables COMPANY LOGO www.themegallery.com Developing hypothesises  The relation between the interest rate, inflation and the output gap is described by A forward-looking Taylor Rule  The interest rate is not adjusted immediately to its desired level but is concerned about interest rate smoothing.  The central bank can have asymmetric preferences that it might assign different weights to expected negative and positive inflation and output gaps in its loss function COMPANY LOGO www.themegallery.com Prediction  The central bank increases the real rate in response to higher inflation, which exerts a stabilizing effect on inflation; on the other hand  In situations in which output is below its potential a decrease in the interest rate will have a stabilizing effect on the economy.  The interest rate is adjusted to desired rate gradually  The central banks’ monetary policy can indeed be described better by a non-linear Taylor rule COMPANY LOGO www.themegallery.com INTRODUCTION  Taylor Rule (1993), of the linear alge- braic interest rate rule that specifies how the Federal Reserve (Fed) of the United States (US) adjusts its Federal Funds target rate to current inflation and output gap.  Extension : Clarida et al. (1998,2000), who suggested the use of a forward-looking version of the Taylor rule where central banks target expected inflation and out- put gap instead of past or current values of these variables COMPANY LOGO www.themegallery.com INTRODUCTION  Important extension is related to the inclusion of asset prices and financial variables in the rule. ASSET PRICES ? [...]... the nonlinear smooth transition regression model 1 The ECB’s monetary policy is better described by a nonlinear monetary rule than by a linear Taylor rule 2 The results also show that the ECB – contrary to the other central banks – con- tinues to consider the information contained in the financial index even after nonlinearities are controlled for 3 we find weak evidence to reject the linear model for the... COMPANY LOGO www.themegallery.com A BRIEF REVIEW OF LITERATURE  Clarida et al (1998,2000) suggest the use of a forward-looking version of the Tay- lor rule where central banks target expected inflation and output gap instead of past or current values of these variables  Fourc¸ ans and Vranceanu (2004) and Sauer and Sturm (2007) also stress the importance of considering a forward-looking Taylor rule. .. of a linear reaction function Kajuth (forthcoming) shows that monetary policy should also react to house prices due to their effects on consumption The issue of financial stability is also investigated by Montagnoli and Napolitano (2005) They build and use a financial conditional indicator that includes the exchange rate, share prices and house prices in the estimation of a Taylor rule for some central. .. nonlinear monetary policy rule used in our analysis takes into account the asymmetries in the macroeconomic model and in the central bank preferences implicitly and general- izes the Taylor rule in the tradition of Clarida et al (1998, 2000) 20 COMPANY LOGO www.themegallery.com A BRIEF REVIEW OF LITERATURE The appli- cation of nonlinear models to the analysis of Central Banks’ policy behaviour: Martin... some central banks 18 COMPANY LOGO www.themegallery.com A BRIEF REVIEW OF LITERATURE The Taylor rule is consid- ered a simple linear interest rate rule that represents an optimal policy- rule under the condition that the central bank is minimising a symmetric quadratic loss function and that the aggregate supply function is linear Asymmetries in monetary policy can result from a nonlinear macroeconomic... (2003), Chadha et al (2004) and Rotondi and Vaciago (2005) consider it Bernanke and Gertler (1999, 2001) and Bullard and Schaling (2002) do not agree with an ex-ante control over asset prices important that cen- tral banks target asset prices COMPANY LOGO www.themegallery.com A BRIEF REVIEW OF LITERATURE Driffill et al (2006) analyse the interactions between monetary policy and the futures market in the... rule COMPANY LOGO www.themegallery.com Specification and estimation of the linear Taylor rule  The linear Taylor rule  The forward-looking version of the Taylor rule  The inclusion of interest rate smoothing in the Taylor rule( *) COMPANY LOGO www.themegallery.com  Inserting Eq (3) into (2) COMPANY LOGO www.themegallery.com Example: Moment Condition From RE  Consider a simple monetary policy rule, ... bijt can be estimated employing the Kalman filter over the state-space form of Eq (9): ***The Kalman filter allows us to recover the dynamic of the relation between the output gap and its explanatory variables COMPANY LOGO www.themegallery.com Kahman Filter COMPANY LOGO www.themegallery.com  This recursive algorithm estimates the state vector as follows:  The weights attached to each variable are then...www.themegallery.com INTRODUCTION Estimate a linear Tay- lor rule for the Eurozone, US and United Kingdom (UK) AIM OF THIS PAPER augmented with a financial conditions index that captures the relevant eco- nomic information contained in some financial variables COMPANY LOGO www.themegallery.com INTRODUCTION A nonlinear model to the study of A nonlinear model to the study of the ECB’s monetary policy, where... begins to respond more forcefully to inflation 21 COMPANY LOGO www.themegallery.com Research methods  Developing a forward-looking version of theTaylor rule with assuming that the central bank does not adjust the interest rate immediately to its desired level but is concerned about interest rate smoothing  Including asset prices and financial variables in the rule  Modeling the nonlinear Taylor rule . a linear Taylor rule with a nonlinear rule COMPANY LOGO www.themegallery.com RESEARCH QUESTION  whether central banks’ monetary policy can indeed be described by a linear Taylor rule or, . LOGO Can central bank’s monetary policy be described by a linear (augmented) Taylor rule or by a monetary rule? GVHD: GS.TS TRẦN NGỌC THƠ SVTH : NHÓM 12-K23 COMPANY LOGO www.themegallery.com SUMMARY Why. gradually  The central banks’ monetary policy can indeed be described better by a non -linear Taylor rule COMPANY LOGO www.themegallery.com INTRODUCTION  Taylor Rule (1993), of the linear alge- braic