Quantifying the Fed’s Objective

Abstract

The Federal Reserve’s objective, namely the dovish stance, is often blamed for the Great Inflation. A popular proxy for the former is constructed based on the inflation coefficients in estimated Taylor rules. However, for a welfare-optimizing central bank, the estimated Taylor coefficients are not sufficient to infer its underlying preference. To reassess this view, we quantify the Fed’s objective — the targeting rule, relying on a conditional estimator that is free of the classical simultaneity problem. In contrast to what is implied by estimating a Taylor rule, we find a stable targeting rule around the pre- and post-Volcker periods.

Keywords: Targeting rule, Central Bank’s Preference, SVAR, Sign Restrictions, Great Inflation, Great moderation

JEL Classification: E31, E32, E52, E58, E65