Additional components appearing in monetary policy rule

Estimation ML/Bayesian estimation
1

Dear Johannes,
Thank you very much for your helpful guidance, I am grateful.
I understand that in Taylor’s monetary policy rule, interest rate responds to current inflation gap and current output gap, however, interest rate can also responds to other things in addition to current inflation gap and output gap. I have two questions.

  1. In addition to inflation and output gaps, should monetary policy respond to future inflation and output gaps, or respond to expected future inflation and output gaps, or responds to forecasts of inflation and output gaps?
  2. In addition to monetary policy shock, can shocks appear in monetary policy rule to represent future inflation and output gaps?
    Thank you very much and look forward to hearing from you.
    Best regards,
    Jesse
2

Hi. Not Professor Pfeifer here, but maybe I can help to elaborate in the first point. And the short answer is yes, maybe check this SGU (2002) paper where they set various monetary policy rules with different timings (lagged, contemporary, forward looking) of gaps, and even use one policy in which gaps are with respect of previous period’s realizations (since it’s the one that needs “the less information”). Hope this helps.

1 Like
3

Dear Johannes,
Thank you very much for your helpful guidance, I am grateful.
I understand that in Taylor’s monetary policy rule, interest rate responds to current inflation gap and current output gap, however, interest rate can also responds to other things in addition to current inflation gap and output gap. I have two questions.

  1. In addition to inflation and output gaps, should monetary policy respond to future inflation and output gaps, or respond to expected future inflation and output gaps, or responds to forecasts of inflation and output gaps?
  2. In addition to monetary policy shock, can shocks appear in monetary policy rule to represent future inflation and output gaps?
    Thank you very much and look forward to hearing from you.
    Best regards,
    Jesse
4

I don’t really know where the question is going. Let’s try to structure things a bit.

  1. In pure model building terms, you can put everything you want into a feedback rule. The only limit is your imagination.
  2. When it comes to the describing actual policies/central bank behavior, things will be different, because central banks may care about very specific things (which will typically differ across countries and time)
  3. Things are again different when doing a normative analysis, i.e. whether feedback rules should respond to particular variables. Here, the answer is not a priori clear.

Regarding your last question: every shock you put into the monetary policy rule will be isomorphic to a monetary policy shock. But you may give it a different interpretation, e.g. anticipated shocks may be forward guidance shocks. What is usually not feasible is having the shocks represent endogenous variables as they are exogenous objects.