Ruhr Economic Papers

Ruhr Economic Papers #334

Empirical Evidence on the Generalized Taylor Principle

by Mario Jovanovic

RUB, 04/2012, 9 S./p., 8 Euro, ISBN 978-3-86788-384-9 DOI: 10.4419/86788384

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Abstract

During financial crises central banks usually decrease interest rates in order to reduce financial uncertainty. This behavior increases inflation risk. The trade-off between inflation and uncertainty stabilization can be modeled by the generalized Taylor rule, which describes inflation sensitivity as a function of financial uncertainty instead of a constant parameter. Based on the GMM-estimation of the generalized approach I confirm the suggested uncertainty-dependent inflation sensitivity of the Fed. Prolonged deviations from the Taylor principle are not evident. This implies that the Fed does not deemphasize inflation stabilization in favor of uncertainty stabilization – especially during the peak of the latest sub-prime crisis.

JEL-Classification: E44, E58

Keywords: Financial instability; time-varying inflation sensitivity

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