Assessing GMM Estimates of the Federal Reserve Reaction Function

Universite de Paris 12 Erudite Working Paper No. 01-04

29 Pages Posted: 4 Dec 2001  

Clementine Florens

University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ)

Eric Jondeau

University of Lausanne - Faculty of Business and Economics (HEC Lausanne); Swiss Finance Institute

Hervé le Bihan

Banque de France - Centre de Recherche

Multiple version iconThere are 2 versions of this paper

Date Written: March 2001

Abstract

Estimating a forward-looking monetary policy rule by the Generalized Method of Moments (GMM) has become a popular approach since the influential paper by Clarida, Gali, and Gertler (1998). However, an abundant econometric literature underlines to the unappealing small-samples properties of GMM estimators. Focusing on the Federal Reserve reaction function, we assess GMM estimates in the context of monetary policy rules. First, we show that three usual alternative GMM estimators yield substantially different results. Then, we compare the GMM estimates with two Maximum-Likelihood (ML) estimates, obtained using a small model of the economy. We use Monte-Carlo simulations to investigate the empirical results. We find that the GMM are biased in small sample, inducing an overestimate of the inflation parameter. The two-step GMM estimates are found to be rather close to the ML estimates. By contrast, iterative and continuous-updating GMM procedures produce more biased and more dispersed estimators.

Keywords: Forward-looking model, monetary policy reaction function, GMM estimator, FIML estimator, small-sample properties of an estimator

JEL Classification: E52, E58, F41

Suggested Citation

Florens, Clementine and Jondeau, Eric and le Bihan, Hervé, Assessing GMM Estimates of the Federal Reserve Reaction Function (March 2001). Universite de Paris 12 Erudite Working Paper No. 01-04. Available at SSRN: https://ssrn.com/abstract=292728 or http://dx.doi.org/10.2139/ssrn.292728

Clementine Florens

University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ) ( email )

Manufacture des Tabacs
21 Allees de Brienne
Toulouse, 31000
France

Eric Jondeau

University of Lausanne - Faculty of Business and Economics (HEC Lausanne) ( email )

Extranef 232
Lausanne, 1012
Switzerland
+41 21 692 33 49 (Phone)

HOME PAGE: http://www.hec.unil.ch/ejondeau/

Swiss Finance Institute ( email )

40, Boulevard du Pont-d'Arve
40, Bd du Pont-d'Arve
1211 Geneva 4, CH-6900
Switzerland
+41 21 692 33 49 (Phone)

Herve Le Bihan (Contact Author)

Banque de France - Centre de Recherche ( email )

31 rue Croix des Petits Champs
Room 41-1391
75049 Paris Cedex 01
France

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