For example, if the Fed chose to target 0 percent inflation while retaining the 1.5 coefficient on expected inflation, the 0.5 coefficient on ygap
, and the 2 percent assumption on [r.sup.*], it would have to raise the intercept in the Taylor rule to 2.0.
However, real GDP (RGDP), output gap (Ygap), domestic credit (LDC), stock price index (SP), CMRate, exchange rate (ER), M2/GDP, domestic borrowing (DBOR) and openness (TT/GDP) are stationary in first difference; I(1).
We also found evidence of a bi-directional causality between outputgap (YGap) and Inflation.
Table 3 Unit Root Tests Result Variable ADF(Levels) ADF(First Difterence) [DELTA][CPI.sub.t-1] -3.429210 ** -5.748879 * USINF -3.003700 ** -6.570895 * RGDP -.0266240 -3.500059 * YGap 0.575690 -5.417021 * DefGDP -3.849298 * [DELTA]M1GDP -5.37479 * LDC 2.725933 -4.817433 * SP -0.749881 -4.082395 * CMRate -2.146065 -7.323656 * ER 2.842852 -3.673984 * M1GDP -4.326640 * -- M2GDP -2.502640 -5.926836 * DBOR 0.064564 -12.40113 * TTGDP -1.815292 -41.200009 * Note: *, ** and *** Indicate the rejection of null at 10 percent, 5 percent and 1 percent respectively.
One advantage of this method in relation to the other univariate methods described above is that both [y.sup.*] and ygap
are modelled directly.
This period, approximately the one focused on by Taylor, encompasses the 1990-1991 recession and ends with the last data point for which Taylor computed ygap
. The solid lines in the figure correspond to the mean path over 1000 draws for the no-change policy, that is, a policy aimed at an FFR target of 8.25%, roughly in line with the Fed's actual policy objective at the end of 1989.
As with the personal income tax elasticity estimates, the weights on En and Ey implied by the regressions move dramatically over time--especially when the sum of ngap and ygap
is close to zero--and thus they are very sensitive to estimates of potential GDP.
Table 1 shows the results of ADF test indicating that all the variables except YGAP are nonstationary at level, however, stationary at first difference.
However, LNEER and YGAP insignificantly affect inflation, whereas, LNEER has expected sign of coefficient.