Non-Linear Taylor Rule through Threshold Estimation

This paper tries to identify non-linearity in the estimation of Taylor type reaction function for Reserve Bank of India using a threshold estimation technique of Hansen (2000). For the monthly data from March 2001 to October 2009 with Repo rate as the policy rate the estimation significantly identifies two thresholds with inflation and one threshold with output gap as threshold variables. We compared this model with that of a naïve univariate model and the typical Taylor type reaction function, the results are in support of the non-linear model in predicting the repo rate at turning points with more accuracy than the other two competing models.