The Yellen Rules
29 Pages Posted: 16 Nov 2016 Last revised: 3 Jun 2017
Date Written: May 24, 2017
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: Suggested Citation