Abstract
The present paper employs a partially generalized ordered probit method to model the Federal Reserve’s monetary policy reaction function. The partially generalized ordered probit method eliminates the parallel regression assumption (which is assumed in ordered probit models) and reveals an important new asymmetry in the Federal Reserve’s actions. The findings indicate that a general monetary reaction function outperforms standard Taylor rule specifications. The Fed takes into account not only inflation and output measures but also several other variables during its decision process, but the degree of its attention on each variable is choice-dependent. The Fed might assign different weights for each macroeconomic factor when it is trying to make a choice, for example, between a big and small decrease or a small decrease and no change in the federal funds target rate. The threshold estimates also indicate that the Federal Reserve acts asymmetrically that it waits for relatively significant changes in the macroeconomic factors before it decides for a change in its target rates. However, once these thresholds are passed, relatively less significant changes in the economy are needed for the Federal Reserve to take action.
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Notes
There are several reasons to believe for non-quadratic loss functions. For more detail see Dolado et al. (2005).
He argues that the FOMC began targeting the funds rate before 1994 and constructed the target series using reports such as the verbatim transcripts of FOMC meetings, the FOMC Blue Book, the Report of Open Market Operations, Money Market Conditions, and etc.
The test results are listed at the bottom of each table.
Actually, it is −0.021 but it is statistically insignificant.
Results for the ordered probit and generalized ordered probit models are not reported to save space and are available upon request from the author.
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Danis, H. Nonlinearity and asymmetry in the monetary policy reaction function: a partially generalized ordered probit approach. Eurasian Econ Rev 7, 161–178 (2017). https://doi.org/10.1007/s40822-017-0069-x
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DOI: https://doi.org/10.1007/s40822-017-0069-x