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The Optimal Design of Interest Rate Target Changes

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  • Guthrie, Graeme
  • Wright, Julian

Abstract

Most central banks currently implement monetary policy by targeting a short-term interest rate. This paper asks: "What is the optimal form for such interest rate targeting, given the objectives facing central banks?" We find the optimal rule is for the central bank to change the target rate whenever the deviation between its preferred rate and the current target rate reaches some critical level, and in this case the target rate is changed by a discrete amount in the direction of its preferred rate. Despite the simplicity of this rule, we are able to replicate a number of puzzling features of interest rate targeting observed in practice, as well as explain some dynamic properties of market interest rates.

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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 36 (2004)
Issue (Month): 1 (February)
Pages: 115-37

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Handle: RePEc:mcb:jmoncb:v:36:y:2004:i:1:p:115-37

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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Cited by:
  1. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  2. RIBONI, Alessandro & RUGE-MURCIA, Francisco, 2006. "The Dynamic (In)efficiency of Monetary Policy by Committee," Cahiers de recherche 02-2006, Centre interuniversitaire de recherche en ├ęconomie quantitative, CIREQ.
  3. Gerlach-Kristen, Petra, 2008. "Taking two steps at a time: On the optimal pattern of policy interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 32(2), pages 550-570, February.
  4. Aaron Drew & L Christopher Plantier, 2000. "Interest rate smoothing in New Zealand and other dollar bloc countries," Reserve Bank of New Zealand Discussion Paper Series DP2000/10, Reserve Bank of New Zealand.

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