Monetary Policy Regime Shifts: New Evidence from Time-Varying Interest-Rate Rules

We estimate forward-looking interest rate rules for five large Organization for Economic Cooperation and Development economies, allowing for time variation in the responses to macroeconomic conditions and in the variance of the policy rate. Conventional constant parameter reaction functions likely blur the impact of (1) model uncertainty, (2) conflicting objectives, (3) shifting preferences, and (4) nonlinearities of policymakers’ choices. We find that monetary policies followed by the United States, the United Kingdom, Germany, France, and Italy are best summarized by feedback rules that allow for time variation in their parameters. Estimates point to sizeable differences in the actual conduct of monetary policies even in countries now belonging to the European Monetary Union. Moreover, our time-varying parameter specification outperforms the conventional Taylor rule and generalized method of moment–based estimates of reaction functions in tracking the actual Fed funds rate.