Threshold Effects in the FED’s Monetary Policy Before and After Inflation Targeting

The present study uses the threshold SVAR models to analyse the periods before and after inflation targeting, covering monthly data between 1992 and 2024. It examines whether the Fed reaction function based on the expanded Taylor equation with the US economic and policy uncertainty index is asymmetric with respect to the inflation and output gap. The results indicate that when inflation is below the 2% threshold, the Fed reacts to economic instability rather than inflation and the output gap. The empirical findings show that once inflation exceeds this level during the inflation targeting period, the Fed reacts to inflation in the long term, output gap in the short term, and economic instability in both the short and long term. Also, when inflation is greater than 2%, the Fed reacts more to expected inflation than to current inflation. Moreover, in post-inflation-targeting period, when inflation rises above this level, the Fed reacts to positive shocks in current inflation with a three-month lag, whereas its reaction to expected inflation is instantaneous. According to the output gap threshold value, it was determined that the Fed's reactions were symmetrical before inflation targeting and asymmetrical afterwards. Empirical findings show that the Fed reacts to economic instability before inflation targeting, to both output gap and economic instability in the short term after inflation targeting, and to inflation in the long run. The results show that the asymmetric effects of the Taylor rule are due to the asymmetric preferences of the Fed.