Estimation of a Forward-Looking Monetary Policy Rule: A Time-Varying Parameter Model Using Ex-Post Data

22 Pages Posted: 22 Oct 2004

See all articles by Chang-Jin Kim

Chang-Jin Kim

Dept. of Economics, University of Washington

Charles R. Nelson

Dept of Economics

Abstract

In this paper, we consider estimation of a time-varying parameter model for a forward-looking monetary policy rule, by employing ex-post data. A Heckman-type (1976) two-step procedure is employed in order to deal with endogeneity in the regressors. This allows us to econometrically take into account changing degrees of uncertainty associated with the Fed's forecasts of future inflation and GDP gap when estimating the model. Even though such uncertainty does not enter the model directly, we achieve efficiency in estimation by employing the standardized prediction errors for inflation and GDP gap as bias correction terms in the second-step regression. We note that no other empirical literature on monetary policy deals with this important issue. Our empirical results also reveal new aspects not found in the literature previously. That is, the history of the Fed's conduct of monetary policy since the early 1970's can in general be divided into three sub periods: the 1970's, the 1980's, and 1990's. The conventional division of the sample into pre-Volcker and Volcker-Greenspan periods could mislead the empirical assessment of monetary policy.

Keywords: Endogeneity, Forward-Looking Monetary Policy, Heteroscedasticity, Nonlinearity, Time-Varying Parameter Model

JEL Classification: E5, C32

Suggested Citation

Kim, Chang-Jin and Nelson, Charles R., Estimation of a Forward-Looking Monetary Policy Rule: A Time-Varying Parameter Model Using Ex-Post Data. Available at SSRN: https://ssrn.com/abstract=607663 or http://dx.doi.org/10.2139/ssrn.607663

Chang-Jin Kim (Contact Author)

Dept. of Economics, University of Washington ( email )

Department of Economics (Box 353330)
University of Washington
Seattle, WA 98195-3330
United States

HOME PAGE: http://https://econ.washington.edu/people/chang-jin-kim

Charles R. Nelson

Dept of Economics ( email )

Box 353330
Seattle, WA 98195-3330
United States

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