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The Central Banker as a Risk Manager: Estimating the Federal Reserve's Preferences under Greenspan
Author(s) -
KILIAN LUTZ,
MANGANELLI SIMONE
Publication year - 2008
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/j.1538-4616.2008.00150.x
Subject(s) - economics , monetary policy , taylor rule , inflation (cosmology) , generalization , maximization , price of stability , interest rate , quadratic equation , output gap , dual (grammatical number) , downside risk , utility maximization , econometrics , central bank , mathematical economics , monetary economics , microeconomics , financial economics , mathematics , portfolio , mathematical analysis , art , physics , geometry , literature , theoretical physics
We derive a natural generalization of the Taylor rule that links changes in the interest rate to the balance of the risks implied by the dual objective of sustainable economic growth and price stability. This monetary policy rule reconciles economic models of expected utility maximization with the risk management approach to central banking. Within this framework, we formally test and reject the standard assumption of quadratic and symmetric preferences in inflation and output that underlies the derivation of the Taylor rule. Our results suggest that Fed policy decisions under Greenspan were better described in terms of the Fed weighing upside and downside risks to their objectives rather than simply responding to the conditional mean of inflation and of the output gap.