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Discrete policy changes and empirical models of the federal funds rate

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  • Michael J. Dueker
  • Robert H. Rasche

Abstract

Empirical models of the federal funds rate almost uniformly use the quarterly or monthly average of the daily rates. One empirical question about the federal funds rate concerns the extent to which monetary policymakers smooth this interest rate. Under the hypothesis of rate smoothing, policymakers set the interest rate this period equal to a weighted average of the rate inherited from the previous quarter and the rate implied by current economic conditions, such as the Taylor rule rate. Perhaps surprisingly, however, little attention has been given to measuring the interest rate inherited from the previous quarter. Previous tests for interest rate smoothing have assumed that the quarterly or monthly average from the previous period is the inherited rate. The authors of this study, in contrast, suggest that the end-of-quarter level of the target federal funds rate is the inherited rate, and empirical tests support this proposition. The authors show that this alternative view of the rate inherited from the past affects empirical results concerning interest rate smoothing, even in relatively rich models that include regime switching.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2004)
Issue (Month): Nov ()
Pages: 61-72

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Handle: RePEc:fip:fedlrv:y:2004:i:nov:p:61-72:n:v.86no.6

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Keywords: Federal funds rate ; Monetary policy;

References

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  1. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August.
  2. 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.
  3. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
  4. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
  5. Michael J. Dueker, 2002. "The monetary policy innovation paradox in VARs: a "discrete" explanation," Review, Federal Reserve Bank of St. Louis, issue Mar., pages 43-50.
  6. Thomas A. Lubik & Frank Schorfheide, 2004. "Testing for Indeterminacy: An Application to U.S. Monetary Policy," American Economic Review, American Economic Association, vol. 94(1), pages 190-217, March.
  7. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 861-886, October.
  8. James D. Hamilton & Oscar Jorda, 2000. "A Model for the Federal Funds Rate Target," NBER Working Papers 7847, National Bureau of Economic Research, Inc.
  9. Ben Bernanke, 1990. "The Federal Funds Rate and the Channels of Monetary Transnission," NBER Working Papers 3487, National Bureau of Economic Research, Inc.
  10. 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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Cited by:
  1. van den Hauwe, Sjoerd & Paap, Richard & van Dijk, Dick, 2013. "Bayesian forecasting of federal funds target rate decisions," Journal of Macroeconomics, Elsevier, vol. 37(C), pages 19-40.
  2. Anatoliy Belaygorod & Michael J. Dueker, 2005. "Discrete monetary policy changes and changing inflation targets in estimated dynamic stochastic general equilibrium models," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 719-34.
  3. Francesca Rondina, 2010. "Policy Evaluation and Uncertainty About the Effects of Oil Prices on Economic Activity," Working Papers 522, Barcelona Graduate School of Economics.

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