Is the Taylor Rule Missing? A Statistical Investigation

Abstract

We conduct a fairly thorough statistical analysis of the empirical foundations for the existence of a Taylor rule. Inflation, the output gap and the federal funds rate appear to be non-stationary variables that are not cointegrated. Although this lack of cointegration could be caused by missing variables or structural breaks, we are unable to 'salvage' the rule using several plausible candidate variables and break dates. We also investigate the possibility that the Taylor rule should be modeled as a non-linear relationship. We find that a simple threshold model makes significant progress towards rectifying some of the shortcomings of the standard model.

Keywords: Taylor rule, interest rate

JEL Classification: E4, E5, C1