Augmenting the Taylor rule: Monetary policy and the bond market

- I augment the Taylor rule using principal components constructed from bond yields.
- The principal components improve the Taylor rule's in-sample and out-of-sample fit.
- The fit improves for both linear and threshold Taylor rules.

I show that augmenting the Taylor rule with bond yields observed at the start of the quarter significantly improves the in-sample and out-of-sample fit. Moreover, the augmented rule produces lower forecast errors than those of linear and non-linear policy models.