Estimation of a Forward-Looking Monetary Policy Rule: A Time-Varying Parameter Model using Ex-Post Data by

In this paper, we consider estimation of a time-varying parameter model for a forwardlooking monetary policy rule, by employing ex-post data. A Heckman-type (1976) 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 in°ation and GDP gap when estimating the model. Even though such uncertainty does not enter the model directly, we achieve e±ciency in estimation by employing the standardized prediction errors for in°ation 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 1970's can in general be divided into three sub periods: the 1970's, the 1980's, and 1990's. The conventional division of the sample into pre-Volcker and VolckerGreenspan periods could mislead the empirical assessment of monetary policy.