Eurasian Economic Review

, Volume 7, Issue 2, pp 161–178 | Cite as

Nonlinearity and asymmetry in the monetary policy reaction function: a partially generalized ordered probit approach

Original Paper
  • 63 Downloads

Abstract

The present paper employs a partially generalized ordered probit method to model the Federal Reserve’s monetary policy reaction function. The partially generalized ordered probit method eliminates the parallel regression assumption (which is assumed in ordered probit models) and reveals an important new asymmetry in the Federal Reserve’s actions. The findings indicate that a general monetary reaction function outperforms standard Taylor rule specifications. The Fed takes into account not only inflation and output measures but also several other variables during its decision process, but the degree of its attention on each variable is choice-dependent. The Fed might assign different weights for each macroeconomic factor when it is trying to make a choice, for example, between a big and small decrease or a small decrease and no change in the federal funds target rate. The threshold estimates also indicate that the Federal Reserve acts asymmetrically that it waits for relatively significant changes in the macroeconomic factors before it decides for a change in its target rates. However, once these thresholds are passed, relatively less significant changes in the economy are needed for the Federal Reserve to take action.

Keywords

Monetary Policy Rules Taylor Rule Generalized Ordered Probit 

JEL Classification

E52 E58 C35 

References

  1. Aksoy, Y., Orphanides, A., Small, D., Wieland, V., & Wilcox, D. (2006). A quantitative exploration of the opportunistic approach to disinflation. Journal of Monetary Economics, 53, 1877–1893.CrossRefGoogle Scholar
  2. Blinder, A. (1998). Central banking in theory and practice. Cambridge, MA: MIT Press.Google Scholar
  3. Clarida, R., Gali, J., & Gertler, M. (1998). Monetary policy rules in practice: Some international evidence. European Economic Review, 42, 1033–1067.CrossRefGoogle Scholar
  4. Clarida, R., Gali, J., & Gertler, M. (2000). Monetary policy rules and macroeconomic stability: Evidence and some theory. Quarterly Journal of Economics, 115(1), 147–180.CrossRefGoogle Scholar
  5. Cukierman, A. (2000). The inflation bias result revisited. Mimeo: Tel Aviv University.Google Scholar
  6. Cukierman, A. (2004). Non linearities in Taylor rules—causes, consequences and evidence. Working Paper.Google Scholar
  7. Dolado, J., Maria-Dolores, R., & Naveira, M. (2005). Are monetary-policy reaction functions asymmetric?: The role of nonlinearity in the Phillips curve. European Economic Review, 49, 485–503.CrossRefGoogle Scholar
  8. Dueker, M. (1999). Measuring monetary policy inertia in target fed funds rate changes. Federal Reserve Bank of St. Louis Review, 3–10.Google Scholar
  9. Florio, A. (2006). Asymmetric interest rate smoothing: The fed approach. Economics Letters, 93,(2) 190–195.CrossRefGoogle Scholar
  10. Di Giorgio, G. (2014). Monetary policy challenges: How central banks changed their modus operandi. Eurasian Economic Review, 4(1), 25–43.CrossRefGoogle Scholar
  11. Hamilton, J., & Jorda, O. (2002). A model of the federal funds rate target. Journal of Political Economy, 110(5), 1135–1167.CrossRefGoogle Scholar
  12. Hu, L., & Phillips, Peter C. B. (2004). Dynamics of the federal funds target rate: A nonstationary discrete choice approach. Journal of Applied Econometrics, 19(7), 851–867.CrossRefGoogle Scholar
  13. Keynes, J. M. (1936). The general theory of employment, interest and money. London: Macmillan.Google Scholar
  14. Levin, A., Wieland, V., & Williams, J. C. (1999). The robustness of simple monetary policy rules under model uncertainty. In J. Taylor (Ed.), Monetary policy rules (pp. 263–299). Chicago: Chicago University Press.Google Scholar
  15. Long, S & Feese, J. (2006). Regression models for categorical dependent variables using Stata (2nd ed.). College Station: Stata Press.Google Scholar
  16. Neftci, S. (1984). Are economic time series asymmetric over the business cycle? Journal of Political Economy, 92(2), 307–328.CrossRefGoogle Scholar
  17. Orphanides, A. (2001). Monetary policy rules based on real-time data. American Economic Review, 91, 964–985.CrossRefGoogle Scholar
  18. Orphanides, A., & Wieland, V. (2000). Inflation zone targeting. European Economic Review, 44(7), 1351–1387.Google Scholar
  19. Orphanides, A., & Wilcox, D. (2002). The opportunistic approach to disinflation. International Finance, 5(1), 47–71.CrossRefGoogle Scholar
  20. Petersen, K. (2007). Does the Federal Reserve follow a non-linear Taylor rule? University of Connecticut Department of Economics Working Paper Series, 2007-37.Google Scholar
  21. Qin, T., & Enders, W. (2008). In-sample and out-of-sample properties of linear and nonlinear Taylor rules. Journal of Macroeconomics, 30(1), 428–443.CrossRefGoogle Scholar
  22. Rudebusch, G. D. (2002). Term structure evidence on interest rate smoothing and monetary policy inertia. Journal of Monetary Economics, 49(6), 1161–1187.CrossRefGoogle Scholar
  23. Shirai, S. (2014). Japan’s monetary policy in a challenging environment. Eurasian Economic Review, 4(1), 3–24.CrossRefGoogle Scholar
  24. Soderlind, P., Soderstrom, U., & Vredin, A. (2005). Dynamic Taylor rules and the predictability of interest rates. Macroeconomic Dynamics, 9, 412–428.CrossRefGoogle Scholar
  25. Taylor, J. B. (1993). Discretion versus Policy Rules in Practice. Carnegie-Rochester Conference Series on Public Policy, 39, 195–214.CrossRefGoogle Scholar
  26. Taylor, M., & Davradakis, E. (2006). Interest rate setting and inflation targeting: evidence of a nonlinear Taylor rule for the United Kingdom. Studies in Nonlinear Dynamics and Econometrics, 10(4), 1–20.Google Scholar
  27. Thornton, D. (2005). A new Federal funds rate target Series: September 27, 1982–December 31, 1993. Federal Reserve Bank of St. Louis Working Paper 2005-032A.Google Scholar
  28. Vanderhart, P. (2000). The Federal Reserve’s reaction function under Greenspan: An ordinal probit analysis. Journal of Macroeconomics, 22(4), 631–644.CrossRefGoogle Scholar

Copyright information

© Eurasia Business and Economics Society 2017

Authors and Affiliations

  1. 1.MUFG Union BankSan FranciscoUSA

Personalised recommendations