Nonlinearity and structural breaks in monetary policy rules with stock prices

This paper introduces nonlinearity and a structural break to the US forward-looking Taylor rule with a stock price gap, thereby alleviating the robustness problem that the linear Taylor rule is sensitive to minor changes of the sample period since 1991. The path of the time-varying inflation coefficient shows that, unlike in the linear model, the Fed consistently responds to inflationary pressures in an aggressive manner even after 1991. The stock price coefficient stays positive since 1991. However, its time-varying pattern does not show active responses in the early periods of stock price hikes, which is counter to the view that the Fed has preemptively reacted to stock price bubbles.