Estimated, Calibrated, and Optimal Interest Rate Rules

Estimated, calibrated, and optimal interest rate rules are examined for their ability to dampen economic fluctuations caused by random shocks. A tax rate rule is also considered. The results show that the estimated interest rate rule used in the paper is stable for the period beginning in 1954 except for the early Volcker period, although more observations, especially high inflation ones, are needed before much confidence can be placed on the results.

The models used for the stabilization results are large scale structural macroeconometric models, and some of the results differ from those based on small models. For example, rules with inflation coefficients less than one are not destabilizing, and rules with large inflation coefficients, such as the Taylor rule, achieve a small reduction in inflation variability at a cost of a large increase in interest rate variability.