TESTING THE TAYLOR RULE FROM 1960-PRESENT: WHERE SHOULD THE FEDERAL FUNDS RATE BE?

Open Access
Author:
Phelps, Victoria Rose
Area of Honors:
Economics
Degree:
Bachelor of Science
Document Type:
Thesis
Thesis Supervisors:
  • Russell Paul Chuderewicz, Thesis Supervisor
  • Russell Paul Chuderewicz, Honors Advisor
  • James R. Tybout, Faculty Reader
Keywords:
  • Taylor Rule
  • Mankiw Rule
  • Economics
  • Federal Reserve
  • Bernanke
  • Burns
  • Volcker
  • Greenspan
  • monetary policy
  • Chuderewicz
Abstract:
In this paper, I examine the effectiveness of the Taylor Rule as a policy rule for the Federal Reserve Bank System in the United States of America. Currently, the Federal Reserve operates under an informal dual mandate, aiming to achieve stable prices and maximize employment. Some politicians and economists have advocated for a more formal rule to guide the Federal Reserve to make policy more predictable and less discretionary. The desire for a more definitive rule can be explained by a variety of different reasons including a lack of democratic influence on the Federal Reserve, a political want for an expanding or growing economy, and for more control over Federal Reserve policies. In this paper, I will use economic data to determine where the Federal Funds rate would have been set in the past based off of the Taylor rule and compare it to the actual Federal Funds Rate. I will contextualize these results with descriptions of the economic environment at that given time to determine the effectiveness of the Taylor Rule Implied Rates. In addition, I will estimate different Federal Reserve Chairs’ sensitivity to inflation gaps and Gross Domestic Product gaps or rather the different alpha coefficients that Taylor discusses in his paper. From these estimations, assumptions regarding the hawkishness or dovishness of a Federal Reserve can be made.