Monetary Policy Regime Shifts: New Evidence from Time-Varying Interest-Rate Rules

Abstract

We estimate forward-looking interest-rate rules for five large OECD economies, allowing for time variation in the responses to macroeconomic conditions and in the variance of the policy rate. Conventional constant-parameter reaction functions likely blur the impact of i) model uncertainty, ii) conflicting objectives, iii) shifting preferences and iv) nonlinearities of policymakers choices. We find that monetary policies followed by the US, the UK, Germany, France and Italy are best summarized by feedback rules that allow for time variation in their parameters. Estimated rules point to sizeable differences in the actual conduct of monetary policies, even in the countries now belonging to the EMU. Also, our TVP specification outperforms the conventional Taylor rule and GMM-based estimates of reaction functions in tracking the actual Fed funds rate.

Keywords: Monetary policy, interest rates, time-varying policy rules

JEL Classification: E52, E58, E60