Taylor Rules and liquidity in financial markets

Emanuele Franceschi (1, 2)

1 PSE - Paris School of Economics
2 PJSE - Paris Jourdan Sciences Economiques

We study the parameter instability in the monetary policy rule followed by the US Federal Reserve Bank since WWII. We find evidence across a variety of econometric methods of fundamental instability, in particular on the parameter governing the reaction to inflation expectations-the Taylor Principle. We augment the monetary policy rule to account for liquidity conditions and find consistent violations of the Taylor Principle without sunspot inflation episodes. We study the presence of multiple regimes and find that when uncertainty and economic slowdown are looming the Fed reacts passively to expected inflation.

Domaines: Economies et finances

Emanuele Franceschi. Taylor Rules and liquidity in financial markets. 2020. ⟨halshs-02978550⟩