Targets in the Taylor Rule: Inflation, Speed Limit, or Price Level?

Abstract

This paper explores the link between alternative targets in the Taylor rule and their empirical fit using real‐time U.S. macroeconomic data. We first study the stabilizing properties of the classical Taylor rule (inflation targeting, IT) and add either a price‐level target (PLT) or output gap quasigrowth target (speed‐limit targeting, SLT) in the context of the standard New Keynesian model. We demonstrate that, although only SLT has the same functional form as the optimal interest‐rate reaction function, both PLT and SLT stabilize the model macroeconomy against a cost‐push shock for a wide range of parameter values better than IT. We then estimate all three specifications using the Greenbook data. We find much stronger support for SLT than PLT and discuss pitfalls in estimating the latter that are present in existing literature.

JEL Classification: E52, E58