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Corresponding Author:
Alessia Cafferata, Department of Management, University of Turin, Italy

Coauthors:
Nicolás Blampied, Department of Management, University of Turin, Italy and Deparment of Economics, Masaryk University, Czech Republic
Luisa Tibiletti, Department of Management, University of Turin, Italy
Mariacristina Uberti, Department of Management, University of Turin, Italy

Optimal Monetary Policy and Taylor Rule Extension

February 20, 2024
JEL classification: E50; E52; E58
Keywords: Inflation; Interest Rates; Output; Taylor Rule; Taylor Principle

Abstract

The Taylor rule constitutes the main tool policy makers rely on to guide monetary policy. In simple words, the rule is a reaction function that determines the short-term interest rate, which responds in the baseline specifications to changes in the inflation gap and the output gap. Since the original paper of Taylor (1993), a large debate has taken place in the literature regarding what the best performing rules are. This paper attempts to analyze the recent literature on the Taylor rule and in particular two important extensions proposed in the last decades: first, we consider whether financial variables should be included in the Taylor rule; second, we analyze the inclusion of the long-term interest rate. From this analysis, we contribute to the understanding of the main monetary policy tool used by any Central Bank and debate whether we find potential variables to extend it.

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Institute for International Economics of the Genoa Chamber of Commerce

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