Masciandaro studies central bankers reactions

How do central bankers react to macroeconomic development? Donato Masciandaro, BAFFI honorary president and MONETA research unit director, sheds light on this issue in his paper “Monetary Policy and Taylor Reaction Functions: Business Cycles, Central Bank Governance and Central Bankers’ Preferences”. The paper aims to review the evolution of the economics of the monetary policy reaction function from Taylor’s seminal contribution to present day. The review is based on two assumptions: 

• the peculiar property of the Taylor rule as a flexible tool explains its pathbreaking nature given its capacity to test multiple economic and institutional cases; 
• this property can be described using a theoretical four-pillar approach.

In this approach, the reaction function is the fourth pillar, which represents the final outcome of three intertwined drivers – business-cycle dynamics, central bank governance and central bankers’ preferences – and is itself a feedback instrument rule. The paper reviews the evolution of the economics of Taylor rule, which has revolutionized the way policymakers think about monetary policy. 

The findings

Given the macroeconomic conditions and the infrequent changes of the monetary regime, the paper highlights the role that the central bankers’ preferences  has played at various points, describing how, after the founding conservative central banker was born, new members of the Taylor rule family progressively emerged: visionary, prudent, holistic and creative central bankers, respectively with their forward-looking, inertial, augmented and shadow reaction functions.

A key takeaway of Masciandaro’s study is the acknowledgment that “one might expect that, armed with the same data (A/N: the first pillar) -and the same mandate (A/N: the second pillar) policymakers would usually reach similar conclusions (A/N: the fourth pillar); what the new evidence shows however is that disagreement is widespread (…). What explains (it)? Differences in beliefs (A/N: the third pillar)”. In other words, the assumptions on the shape and the drivers that characterizes the central bankers’ preferences need to be always updated using new knowledge. Eventually, the Taylor rule can be as good a guide for analysis as the inputs the researchers plug into it, but also depending on the researchers’ quality in picking up, time to time, the best member of the Taylor family for the identification and evaluation of the monetary policy stance.