THE ECONOMETRICS OF MACROECONOMIC MODELLING

Ex post calculated interest rate rules

To get a feel for the properties and implications of the different monetary policy rules in Table 10.1, we have calculated ex post interest rates corresponding to the different rules, by inserting the actual outcomes of the variables into the various versions of equation (10.1). The results are shown in the four charts in Figure 10.3. The upper left panel shows the realised interest rate together with the implied interest rate of following the flexible rule FLX. Following the rule would have meant a much higher interest rate during 1997, as a consequence of the spurt in output growth, shown in Figure 10.2(b). The strict rule ST of the upper right panel is basically reflecting the development of underly­ing inflation of Figure 10.2(a), while the smoothing rule SM appears more

Figure 10.2. Data series for the variables which are used in the Taylor rules,
‘real time’-rules and open economy-rules respectively, over the period
1995(1)-2000(4). (a) Taylor rules: headline inflation, A4pt, and underlying
inflation, A4put. (b) Taylor rules: output growth, A4yt. (c) ‘Real time’ rules:
unemployment, ut, wage growth, A4wt, and credit growth A4ncrt. (d) Open
economy rules: deviations from PPP, vt — (pt — pwt)

volatile, again reflecting the output growth volatility—even though the rule implies considerable interest rate smoothing. Of the real-time rules, unemploy­ment and credit growth appear the smoothest, while the wage growth rule WF would imply a very contractive response to the wage hikes. Finally, the real exchange rate rule RX implies quite volatile interest rate responses. Of course, these responses are only indicatory, as there is no feedback onto the variables entering the different rules. In later sections of this chapter we will investi­gate the properties of these rules in counterfactual model simulations, where we allow the economy to react to changes in monetary policy according to the prescribed interest rate rules, and the changed outcome for the set of variables in each rule will feed back and change the interest rate according to the rule.