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The Taylor rule: can it be supported by the data?

Leon, Costas (2006): The Taylor rule: can it be supported by the data?

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Abstract

The Taylor equation is a simple monetary policy rule that determines the Central Bank’s policy rate as a function of inflation and output. A significant body of literature verifies the consistency of the Taylor rule with the data. However, recently there has been a growing literature regarding the validity of the estimated parameters due to the non-stationarity of the interest rate. In this paper I test the consistency of the Taylor rule with the Greek data for the period 1996-2004. It appears that the data do not support the Taylor rule in the sense that they do not form a cointegration set of variables. Therefore, the estimated parameters should be considered fragile and the forecasting for the interest rate as a function of inflation and output should not be expected to be adequately consistent with the actual data.

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