Estimation of a forward-looking monetary policy rule: A time-varying parameter model using ex post data
Chang-Jin Kim, Charles R. Nelson



Abstract
In this paper, we consider estimation of a time-varying parameter model for a forward-looking
monetary policy rule, by employing ex post data. A Heckman-type (1976. The common structure of
statistical models of truncation, sample selection, and limited dependent variables and a simple
estimator for such models. Annals of Economic and Social Measurement 5, 475–492) two-step
procedure is employed in order to deal with endogeneity in the regressors. This allows us to
econometrically take into account changing degrees of uncertainty associated with the Fed’s forecasts
of future inflation and GDP gap when estimating the model. Even though such uncertainty does not
enter the model directly, we achieve efficiency in estimation by employing the standardized prediction
errors for inflation and GDP gap as bias correction terms in the second-step regression. We note that
no other empirical literature on monetary policy deals with this important issue. Our empirical results
also reveal new aspects not found in the literature previously. That is, the history of the Fed’s
conduct of monetary policy since the early 1970s can in general be divided into three subperiods: the
1970s, the 1980s, and the 1990s. The conventional division of the sample into pre-Volcker and
Volcker–Greenspan periods could mislead the empirical assessment of monetary policy.