2008
20/2008
Estimating regime-switching Taylor rules with trend inflation
Author(s): Efrem Castelnuovo – Luciano Greco – Davide Raggi
2008. 40 pages.
Publisher: Bank of Finland
ISBN 978-952-462-456-5 (Printed publication)
ISBN 978-952-462-457-2 (Web publication)
Search words: active and passive Taylor rules, trend inflation, inflation gap persistence, Markov-switching models, E52, E61, E62, Efrem Castelnuovo, Luciano Greco, Davide Raggi
This paper estimates regime-switching monetary policy rules featuring trend inflation using post-WWII US data. We find evidence in favour of regime shifts and time-variation of the inflation target. We also find a drop in the inflation gap persistence when entering the Great Moderation sample. Estimated Taylor rule parameters and regimes are robust across different monetary policy models. We propose an ‘internal consistency’ test to discriminate among our estimated rules. Such a test relies upon a feedback mechanism running from the monetary policy stance to the inflation gap. Our results support the stochastic autoregressive process as the most consistent model for trend inflation, above all when conditioning to the post-1985 subsample.