The Taylor curve: international evidence

ABSTRACT

We use the Taylor curve to gauge deviations of monetary policy from an efficiency locus for the United Kingdom (UK) and the four largest economies of the Eurozone (Germany, France, Italy, Spain) for the period 2000–2018. For this purpose, we use shadow interest rates, which is a common metric for both conventional and unconventional monetary policies, and the newly proposed Hamilton-filter to measure output gap, which improves upon the drawbacks of the traditionally used Hodrick–Prescott filter. Our findings suggest that deviations in the UK mostly occurred amid the global financial crisis and the post-Brexit period, whereas Eurozone members experienced more volatile deviations around 2001, during the global financial crisis and the Eurozone sovereign debt crisis.

KEYWORDS:

• Taylor curve
• monetary policy
• eurozone
• hp filter

JEL CLASSIFICATION:

• E31
• E58
• C32

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ For authors who attribute the decline in inflation levels and volatilities to changes in the conduct of monetary policy, see among others Galí and Gambetti (2009) for the US, Batini and Nelson (2005) for the UK and Avouyi-Dovi and Sahuc (2016) for the euro area.

² We calculate two orthogonal distance measure in order to calculate our measures. That is, we first calculate the minimum distance between the observed volatilities and the efficiency frontier:

$d_{min}=\sqrt{{\left({\sigma }_{\pi }^{optimal}-{\sigma }_{\pi }^{observed}\right)}^2+{\left({\sigma }_y^{optimal}-{\sigma }_y^{observed}\right)}^2}$

We subsequently calculate the minimum distance between the efficiency frontier and the origin:

$d_{min1}=\sqrt{{\left(0-{\sigma }_{\pi }^{optimal}\right)}^2+{\left(0-{\sigma }_y^{optimal}\right)}^2}$

and then divide $d_{min}$/$d_{min1}$. Because the efficiency frontier is in output volatility and inflation volatility space, the units are best thought of as combinations of output and inflation volatilities.

³ The data is available for download from the website of Professor Jing Cynthia Wu at: https://sites.google.com/view/jingcynthiawu/shadow-rates?authuser=0.

⁴ The shadow rate for the Eurozone is available for the period after 2004. Because shadow rates and nominal interest rates exhibit minimal discrepancy before the 2008 period, i.e. during the period when shadow rates are not negative, this approach does not pose a methodological challenge. Table A1 displays the summary statistics for the variables used in the analysis.

⁵ See for example (OECD 2001a).