Alex Nikolsko‐Rzhevskyy

Taylor Rules and the Euro.

This paper uses real-time data to show that inflation and either the output gap or unemployment, the variables which normally enter central banks Taylor rules for interest-rate-setting, can provide evidence of out-of-sample predictability and forecasting ability for the United States Dollar/Euro exchange rate from the inception of the Euro in 1999 to the end of 2007. We also present less formal evidence that, with real-time data, the Taylor rule provides a better description of ECB than of Fed policy during this period. The strongest evidence is found for specifications that neither incorporate interest rate smoothing nor include the real exchange rate in the forecasting regression, and the results are robust to whether or not the coefficients on inflation and the real economic activity measure are constrained to be the same for the U.S. and the Euro Area. The evidence is stronger with inflation forecasts than with inflation rates and with real-time data than with revised data. Bad news about inflation and good news about real economic activity both lead to out-of-sample predictability and forecasting ability through forecasted exchange rate appreciation.

Deviations from Rules-Based Policy and Their Effects

Rules-based monetary policy evaluation has long been central to macroeconomics. Using the original Taylor rule, a modified Taylor rule with a higher output gap coefficient, and an estimated Taylor rule, we define rules-based and discretionary eras by smaller and larger policy rule deviations, the absolute value of the difference between the actual federal funds rate and the federal funds rate prescribed by the three rules. We use tests for multiple structural changes to identify the eras so that knowledge of subsequent economic outcomes cannot influence the choice of the dates. With the original Taylor rule, monetary policy in the U.S. is characterized by a rules-based era until 1974, a discretionary era from 1974 to 1985, a rules-based era from 1985 to 2000, and a discretionary era from 2001 to 2013. With the modified Taylor rule, the rules-based era extends further into the 1970s and there is an additional rules-based period starting in 2006. We calculate various loss functions and find that economic performance is uniformly better during rules-based eras than during discretionary eras, and that the original Taylor rule provides the largest loss during discretionary periods relative to loss during rules-based periods.

Markov Switching and the Taylor Principle

Early research on the Taylor rule typically divided the data exogenously into pre-Volcker and Volcker-Greenspan subsamples.  We contribute to the recent trend of endogenizing changes in monetary policy by estimating a real-time forward-looking Taylor rule with endogenous Markov switching coefficients and variance. The response of the interest rate to inflation is regime dependent, with the pre and post-Volcker samples containing monetary regimes where the Fed did and did not follow the Taylor principle. While the Fed consistently adhered to the Taylor principle before 1973 and after 1984, it followed the Taylor principle from 1975-1979 and did not follow the Taylor principle from 1980-1984.  We also find that the Fed only responded to real economic activity during the states in which the Taylor principle held.  Our results are consistent with the idea that exogenously dividing postwar monetary policy into pre-Volcker and post-Volcker samples misleading. The greatest qualitative difference between our results and recent research employing time varying parameters is that we find that the Fed did not adhere to the Taylor Principle during most of Paul Volcker’s tenure, a finding which accords with the historical record of monetary policy.

Taylor's Rule Versus Taylor Rules

Does the Taylor rule prescribe negative interest rates for 2009-2011? This question is important because negative prescribed interest rates provide a justification for quantitative easing once actual policy rates hit the zero lower bound. We answer the question by analyzing Fed policy following the recessions of the early-to-mid 1970s, the early 1990s, and the early 2000s in the context of both Taylor’s original rule and latter variants of Taylor rules. While Taylor’s original rule, which can be justified by historical experience during and following the recessions, does not produce negative prescribed interest rates for 2009-2011, variants of Taylor rules with larger output gap coefficients, which do produce negative interest rates, cannot be justified by the same historical experience. We conclude that the Taylor rule does not provide a rationale for quantitative easing.

Taylor) Rules versus Discretion in U.S. Monetary Policy

The Taylor rule has been the dominant metric for monetary policy evaluation over the past 20 years, and it has become common practice to identify periods where policy either adheres closely to or deviates from the Taylor rule benchmark. The purpose of this paper is to identify (Taylor) rules-based and discretionary eras solely from the data so that knowledge of subsequent economic outcomes cannot influence the choice of the dates. We define Taylor rules-based and discretionary eras by smaller and larger Taylor rule deviations, the absolute value of the difference between the actual federal funds rate and the federal funds rate prescribed by the original Taylor rule, and use tests for multiple structural changes and Markov switching models to identify the eras. Monetary policy in the U.S. is characterized by a Taylor rules-based (low deviations) era until 1974, a discretionary (high deviations) era from 1974 to about 1985, a rules-based era from about 1985 to 2000, and a discretionary era from 2001 to 2008. The Taylor rule deviations are about three times as large in the discretionary eras than in the rules-based eras and are almost four times larger in the most discretionary era (1974 to 1984) than in the least discretionary era (1985 to 2000). With the Markov switching models, which allow for regime changes at the beginning and end of the sample, we also identify a discretionary era from 1965 to 1968 and a rules-based era in 2006 and 2007. The discretionary and rules-based eras closely correspond to periods where the Taylor rule deviations are above and below two percent.

Foreign Direct Investment and Export Performance in Emerging Economies: Evidence from Indian IT Firms

The effects of FDI on export behavior of both recipients and non-recipient competing firms in the same sector often guides economic development policy. We estimate a Logit model of the probability of export and Pooled Tobit and Fixed and Random Effects Tobit models of the volume of exports using a large sample of Indian Information Technology firms in 2000-2006 that focus on the role of FDI. For FDI recipients the probability of exporting and the volume of exports is greater. In addition, there is clear evidence of a spillover of the effects of FDI to non-recipient firms as their probability of exporting also increase. In a random effects Tobit model spillover also exists for the volume of exports.

Real-Time Historical Analysis of Monetary Policy Rules

The size of the output gap coefficient is the key determinant of whether quantitative easing since 2009 and continued near-zero interest rates can by justified by a Taylor rule. Fed Chair Ben Bernanke and Vice-Chair Janet Yellen have argued that John Taylor proposed a monetary policy rule with a larger output gap coefficient in his 1999 paper than in his 1993 paper, and have used this argument to justify negative prescribed interest rates in 2009-2010 and near-zero interest rates through 2015. While Taylor neither proposed nor advocated a different rule in 1999 than in 1993, he did not draw a distinction between the implications of the two rules. In accord with common practice at the time, Taylor used revised data. We show that, using real-time data available to policymakers (although not to Taylor when he wrote the paper), there is a sharp difference in the implications of rules with a smaller and a larger output gap coefficient. If John Taylor had been able to use real-time data in his 1999 paper, the importance of the distinction between Taylor’s original rule with a smaller output gap coefficient and other rules with a larger coefficient would have been evident much earlier.

The Taylor Principles

We use tests for structural change to identify periods of low, positive, and negative Taylor rule deviations, the difference between the federal funds rate and the rate prescribed by the original Taylor rule. The tests define four monetary policy eras: a negative deviations era during the Great Inflation from 1965 to 1979, a positive deviations era during the Volcker disinflation from 1979 to 1987, a low deviations era during the Great Moderation from 1987 to 2000, and another negative deviations era from 2001 to 2014. We then estimate Taylor rules for the different eras. The most important violations of the Taylor principles, the four elements that comprise the Taylor rule, are that the coefficient on inflation was too low during the Great Inflation and that the coefficient on the output gap was too low during the Volcker disinflation. We then analyze deviations from several alterations of the original Taylor rule, which identify a negative deviations era from 2000 to 2007 and a low deviations era from 2007 to 2014. Between 2000 and 2007, Fed policy cannot be explained by any variant of the Taylor rule while, between 2007 and 2014, Fed policy is consistent with a rule where the federal funds rate does not respond at all to inflation and either responds very strongly to the output gap or incorporates a time-varying equilibrium real interest rate.

Violent Conflict and Online Segregation: An Analysis of Social Network Communication Across Ukraine's Regions

Does the intensity of a social conflict affect political division? Traditionally, social cleavages are seen as the underlying cause of political conflicts. It is clear, however, that a violent conflict itself can shape partisan, social, and national identities. In this paper, we ask whether social conflicts unite or divide the society by studying the effects of Ukraines military conflict with Russia on online social ties between Ukrainian provinces (oblasts). In order to do that, we collected original data on the cross-regional structure of politically relevant online communication among users of VKontakte social networking site. We analyze the panel of provinces spanning the most active phases of domestic protests and military conflict and isolate the effects of province-specific war casualties on the nature of inter-provincial online communication. The results show that war casualties entice strong emotional response in the corresponding provinces, but do not necessarily increase the level of social cohesion in inter-provincial online communication. We find that the intensity of military conflict entices online activism, but activates regional rather than nation-wide network connections. We also find that military conflict tends to polarize some regions of Ukraine, especially in the East. Our research brings attention to the underexplored areas in the study of civil conflict and political identities by documenting the ways the former may affect the latter.

The Yellen rules

Abstract Suppose that the Fed were to adopt a policy rule. Which rule should it adopt? We propose three criteria. First, the rule should be consistent with good economic performance over a long historical period. Second, the rule should be consistent with recent Fed policy following the Great Recession. Third, the rule should be consistent with projected Fed policy. The first criterion is normative, while the second and third criteria are pragmatic. We consider three rules that have been the focus of extensive policy discussion. The Taylor (1993) and Yellen (2015) rules are “balanced” in the sense that the coefficients on the inflation and output gaps are equal, while the Yellen (2012) rule is an example of an “output gap tilting” rule because the coefficient on the output gap is larger than the coefficient on the inflation gap. We also consider “inflation gap tilting” rules where the coefficient on the inflation gap is larger than the coefficient on the output gap. An inflation gap tilting version of the Yellenxa0(2015a) rule with a time-varying equilibrium real interest rate provides the most consistency with the three criteria. This paper was prepared for “Monetary Rules for a Post-Crisis World,” Mercatus-CMFA Academic Conference, September 7, 2016. We thank the participants at the conference for helpful comments and discussions.