mentioned in the Introduction, this rule has been shown to provide a good
description of the US monetary policy since 1987. Following the now extensive
literature on asset prices and monetary policy (see, for example, (Cecchetti,
Genberg, Lipsky, and Wadhwani 2000)), we also look at the results for a Taylor
rule that includes a reaction to asset prices (TR+q). The coefficient on asset
prices is 0.1, as in (Bernanke and Gertler 1999).
Several authors have concluded that monetary policy responds to the expected
value of inflation rather than to current or past inflation (see, for example,
(Clarida, Gali, and Gertler 2000)). (Levin, Wieland, and Williams 2003)
provide a discussion of the rationale and robustness of inflation-forecast based
rules. We consider a simple inflation-forecast based policy rule (IFB) where
the interest rate responds to deviations of expected inflation from the target.
We also experiment an inflation-forecast based rule with an expected output
term (IFB+y) and with an expected output term and an asset price term
(IFB+y+q). The coefficients in the inflation-forecast based policy rules are as
in the Taylor rule, that is, 1.5 coefficient in the expected inflation and 0.5 in the
expected output. The coefficient on asset prices is 0.1, again as in (Bernanke
and Gertler 1999). We also tried a stronger reaction to expected inflation,
with coefficient 2.0 in the case of rule IFB+y+q aggressive. The coefficients on
Etπt+1 and Etyt+1 for forecast-based rules were chosen so as to be close to 1.5,
among values for which the algorithm of (Svensson and Williams 2005) could
find a solution to the model.
3 Soft landing in a Markov-switching economy
In this paper we investigate the limits of simple Taylor-type rules at moderating
the disruptive effects of asset market disturbances and whether central banks
may have incentives to deviate from the prescriptions of Taylor-type rules. We
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