Disentangling Permanent and Transitory Monetary Shocks with a Nonlinear Taylor Rule

Abstract This article provides an estimation method to decompose monetary policy innovations into persistent and transitory components using the nonlinear Taylor rule proposed in Andolfatto, Hendry, Moran (2008) [Are inflation expectations rational? Journal of Monetary Economics , 55 406–422]. To use Kalman filter as optimal signal extraction technique, we a convenient reformulation for state equation by allowing play significant role explaining future time evolution shocks. alternative formulation allows us perform maximum likelihood all parameters involved well recover conditional probabilities regime change. Empirical evidence on US making is provided period covering 1986-Q1 2021-Q2. We compare our empirical estimates with those obtained based particle filter. While both procedures lead similar quantitative qualitative findings, approach has much less computational cost.