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Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence

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  • Sack, Brian
  • Wieland, Volker

Abstract

The Federal Reserve and other central banks tend to change short-term interest rates in sequences of small steps in the same direction and reverse the direction of interest rate movements only infrequently. These characteristics, often referred to as interest-rate smoothing, have led to criticism that policy responds too little and too late to macroeconomic developments, suggesting to some observers that the Federal Reserve has an objective of minimizing interest-rate volatility. This paper, however, argues that the observed degree of interest-rate smoothing may well represent optimal behavior on the part of central banks whose only objectives are to stabilize output and inflation. We summarize recent research on three different explanations of interest-rate smoothing: forward-looking behavior by market participants, measurement error associated with key macroeconomic variables, and uncertainty regarding relevant structural parameters.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economics and Business.

Volume (Year): 52 (2000)
Issue (Month): 1-2 ()
Pages: 205-228

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Handle: RePEc:eee:jebusi:v:52:y:2000:i:1-2:p:205-228

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Web page: http://www.elsevier.com/locate/jeconbus

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References

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  1. Lars E. O. Svensson, 2000. "Open-Economy Inflation Targeting," NBER Working Papers 6545, National Bureau of Economic Research, Inc.
  2. Fuhrer, Jeffrey C, 1997. "Inflation/Output Variance Trade-Offs and Optimal Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(2), pages 214-34, May.
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  9. Wieland, Volker, 2003. "Monetary Policy and Uncertainty about the Natural Unemployment Rate," CFS Working Paper Series 2003/05, Center for Financial Studies (CFS).
  10. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  11. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
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  13. John C. Williams, 2003. "Simple rules for monetary policy," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12.
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  15. Alexei Onatski & James H. Stock, 1999. "Robust monetary policy under model uncertainty in a small model of the U.S. economy," Proceedings, Federal Reserve Bank of San Francisco.
  16. Athanasios Orphanides & Volker Wieland, 1998. "Price stability and monetary policy effectiveness when nominal interest rates are bounded at zero," Finance and Economics Discussion Series 1998-35, Board of Governors of the Federal Reserve System (U.S.).
  17. Arturo Estrella & Frederic S. Mishkin, 2000. "Rethinking the Role of NAIRU in Monetary Policy: Implications of Model Formulation and Uncertainty," NBER Working Papers 6518, National Bureau of Economic Research, Inc.
  18. Charles Goodhart, 1998. "Central Bankers and Uncertainty," FMG Special Papers sp106, Financial Markets Group.
  19. Volker Wieland, 1999. "Monetary policy, parameter uncertainty and optimal learning," Finance and Economics Discussion Series 1999-48, Board of Governors of the Federal Reserve System (U.S.).
  20. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
  21. Laurence Ball, 1997. "Efficient Rules for Monetary Policy," NBER Working Papers 5952, National Bureau of Economic Research, Inc.
  22. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, December.
  23. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  24. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy Rules for Inflation Targeting," NBER Working Papers 6512, National Bureau of Economic Research, Inc.
  25. Philip Lowe & Luci Ellis, 1997. "The Smoothing of Official Interest Rates," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
  26. David E Lindsey, 1997. "Discussion of 'The Smoothing of Official Interest Rates'," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
  27. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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