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The Yellen Rules

29 Pages Posted: 16 Nov 2016 Last revised: 3 Jun 2017

Alex Nikolsko‐Rzhevskyy

Lehigh University - Department of Economics

David H. Papell

University of Houston - Department of Economics

Ruxandra Prodan

University of Houston - Department of Economics

Date Written: May 24, 2017

Abstract

Suppose that the Fed were to adopt a policy rule. Which rule should it adopt? We propose three criteria. First, the rule should be consistent with good economic performance over a long historical period. Second, the rule should be consistent with recent Fed policy following the Great Recession. Third, the rule should be consistent with projected Fed policy. The first criterion is normative, while the second and third criteria are pragmatic. We consider three rules that have been the focus of extensive policy discussion. The Taylor (1993) and Yellen (2015) rules are “balanced” in the sense that the coefficients on the inflation and output gaps are equal, while the Yellen (2012) rule is an example of an “output gap tilting” rule because the coefficient on the output gap is larger than the coefficient on the inflation gap. We also consider “inflation gap tilting” rules where the coefficient on the inflation gap is larger than the coefficient on the output gap. An inflation gap tilting version of the Yellen (2015) rule with a time-varying equilibrium real interest rate provides the most consistency with the three criteria.

Keywords: Taylor rules, monetary rules, constrained discretion

JEL Classification: E52, E58

Suggested Citation

Nikolsko‐Rzhevskyy, Alex and Papell, David H. and Prodan, Ruxandra, The Yellen Rules (May 24, 2017). Available at SSRN: https://ssrn.com/abstract=2869223 or http://dx.doi.org/10.2139/ssrn.2869223

Alex Nikolsko-Rzhevskyy

Lehigh University - Department of Economics ( email )

620 Taylor Street
Bethlehem, PA 18015
United States

HOME PAGE: http://www.nikolsko-rzhevskyy.com

David H. Papell (Contact Author)

University of Houston - Department of Economics ( email )

Houston, TX 77204-5882
United States

Ruxandra Prodan

University of Houston - Department of Economics ( email )

Houston, TX 77204
United States

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