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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. 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.
  2. 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.
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  4. Wieland, Volker, 2000. "Monetary policy, parameter uncertainty and optimal learning," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 199-228, August.
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  7. Coenen Günter & Orphanides Athanasios & Wieland Volker, 2004. "Price Stability and Monetary Policy Effectiveness when Nominal Interest Rates are Bounded at Zero," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-25, February.
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  9. Laurence Ball, 1997. "Efficient Rules for Monetary Policy," NBER Working Papers 5952, National Bureau of Economic Research, Inc.
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  18. Frank Smets, 2002. "Output gap uncertainty: Does it matter for the Taylor rule?," Empirical Economics, Springer, vol. 27(1), pages 113-129.
  19. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series 1998-03, Board of Governors of the Federal Reserve System (U.S.).
  20. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers 638, Stockholm - International Economic Studies.
  21. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters, in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
  22. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 263-318 National Bureau of Economic Research, Inc.
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  24. 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.
  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.
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