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Using the Taylor rule to analyze monetary policy

Miles B. Cahill, College of the Holy Cross.

An earlier version of this exercise appeared in my working paper presented at the 2006 AEA meetings titled Estimating key macroeconomic relationships at the undergraduate level: Taylor rule and Okun's Law examples"
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This material is replicated on a number of sites as part of the SERC Pedagogic Service Project

Summary

In this exercise, students compute the federal funds rate target values of the Taylor (1993) monetary policy rule. The resulting data can be used to analyze policy during the various Federal Reserve regimes since 1970. For example, the Fed seemed to keep the inflation rate too low during the 1970s stagflation period, had a high target during the disinflation period of the 1980s, and may have kept the interest rate too low in the 2000s. The exercise replicates a key part of the Taylor (1993) paper and improves on it.

Learning Goals

Students should understand the Taylor monetary policy rule and make inferences on policy conducted under different chairmanships.

Context for Use

This exercise may be tailored to a variety of environments and gradable assignments. It can be taught as a laboratory session, used in lecture to prompt discussion, and may be assigned outside of class. A variety of assignments may be constructed from it, including short or long papers, or shorter assignments.

Description and Teaching Materials

These materials consist of an assignment instruction sheet for students, detailed instructions and notes for the instructor, and a sample completed spreadsheet (using data through 2005).


Teaching Notes and Tips

This exercise may be tailored to different levels of student involvement. As presented, students are asked to choose data series, find the data, format it properly, make calculations and construct charts. This may be time-consuming so the instructor may choose to provide parts of the assignment to the student - e.g. the raw or formatted data. It can be used as a basis for a discovery learning approach to monetary policy history, as the basis for short or longer term papers, or stand-alone assignments.

Assessment

Students may be asked to hand in a paper describing the results and providing some analysis. In addition, students may be required to hand in completed spreadsheets.

References and Resources

The data for the assignment may be found at the Federal Reserve Bank of St. Louis FRED database

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