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Discrete monetary policy changes and changing inflation targets in estimated dynamic stochastic general equilibrium models

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  • Anatoliy Belaygorod
  • Michael J. Dueker

Abstract

Many estimated macroeconomic models assume interest rate smoothing in the monetary policy equation. In practice, monetary policymakers adjust a target level for the federal funds rate by discrete increments. One often-neglected consequence of using a quarterly average of the daily federal funds rate in empirical work is that any change in the target federal funds rate will affect the quarterly average in the current quarter and the subsequent quarter. Despite this clear source of predictable change in the quarterly average of the federal funds rate, the vast bulk of the literature that estimates policy rules ignores information concerning the timing and magnitude of discrete changes to the target federal funds rate. Consequently, policy equations that include interest rate smoothing inadvertently make the strong and unnecessary assumption that the starting point for interest rate smoothing is last quarter's average level of the federal funds rate. The authors consider, within an estimated general equilibrium model, whether policymakers put weight on the end-of-quarter target level of the federal funds rate when choosing a point at which to smooth the interest rate.

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Bibliographic Info

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

Volume (Year): (2005)
Issue (Month): Nov ()
Pages: 719-34

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Handle: RePEc:fip:fedlrv:y:2005:i:nov:p:719-34:n:v.87no.6

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Keywords: Monetary policy ; Inflation (Finance);

References

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Citations

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Cited by:
  1. Pablo Pincheira & Mauricio Calani, 2010. "Communicational Bias in Monetary Policy: Can Words Forecast Deeds?," JOURNAL OF LACEA ECONOMIA, LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
  2. Fair, Ray C., 2007. "Evaluating Inflation Targeting Using a Macroeconometric Model," Economics Discussion Papers 2007-14, Kiel Institute for the World Economy.
  3. Calani, Mauricio, 2007. "Testing Globalization-Disinflation Hypothesis," MPRA Paper 4787, University Library of Munich, Germany, revised 10 Sep 2007.
  4. Todd E. Clark & Troy Davig, 2008. "An empirical assessment of the relationships among inflation and short- and long-term expectations," Research Working Paper RWP 08-05, Federal Reserve Bank of Kansas City.
  5. Fabio Milani, 2006. "The Evolution of the Fed's Inflation Target in an Estimated Model under RE and Learning," Working Papers 060704, University of California-Irvine, Department of Economics.

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