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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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  20. Coenen, Günter & Orphanides, Athanasios & Wieland, Volker, 2003. "Price stability and monetary policy effectiveness when nominal interest rates are bounded at zero," Working Paper Series 0231, European Central Bank.
  21. 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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  23. Wieland, Volker, 2003. "Monetary Policy and Uncertainty about the Natural Unemployment Rate," CEPR Discussion Papers 3811, C.E.P.R. Discussion Papers.
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