— see, for example, (Clarida, Gali, and Gertler 2000).
An extensive literature on monetary-policy rules suggests that to follow a
specific simple rule may be the best prescription to a good monetary policy —
see, for example, (Taylor 1999). The Taylor rule was proposed as a guideline for
assessing interest rate decisions (Taylor 1993). Additionally, financial market
analysts, scholars and central banks’ staff have been using monetary policy
rules increasingly to forecast interest rates and to evaluate and describe central
bank policy actions — see, for example, (Judd and Trehan 1995) and (Blinder
and Reis 2006). The Taylor rule has provided a good description of monetary
policy under Alan Greenspan’s mandate — see (Rudebusch 2006) and Figure
1. However, Taylor rule’s inflation and unemployment coefficients are better
seen as “historically average responses”1 rather than as a literal description
of the actual monetary policy of the Federal Reserve (Blinder and Reis 2006).
Actually, the Federal Reserve has deviated from interest rate movements implied
by the Taylor rule on several occasions. Those deviations of the US monetary
policy have been associated with high risks of financial markets disruptions
(Greenspan 2004). The stock market collapse in 1987 and the 1998 Russian
debt default, followed by the demise of the Long-Term Capital Management
hedge fund were two such episodes of monetary policy easing relative to the
Taylor rule prescription. The terrorist attack of September 11 was another
instance involving a high risk of financial instability and an aggressive monetary
easing. More recently, following the sub-prime crisis, the Federal Reserve has
cut the Feds Fund rate in 300 basis points, between August 2007 and March
2008.
(Taylor 2007), although recognising that the Taylor rule is not supposed
to be followed mechanically, argues that monetary policy might deliver better
results, in terms of low inflation and output variability, by staying closer to the
1This was the expression used by (Greenspan 2004).