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Interest Rate Rules in an Estimated Sticky Price Model

In: Monetary Policy Rules

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  • Julio J. Rotemberg
  • Michael Woodford

Abstract

This paper evaluates alternative rules by which the Fed may set interest rates using the small model of the U.S. economy estimated in Rotemberg and Woodford (1997). Our main substantive finding is that low and stable inflation together with stable interest rates can be achieved by letting the funds rate respond positively to inflation while also responding, with a coefficient bigger than one, to the lagged funds rate itself. A rule in which the interest rate is set in this extremely simple way does almost as well as a more complicated rule which is optimal in our setting, in the sense of maximizing expected utility to the representative household. Furthermore, when the funds rate responds to inflation only with a delay, due to delay in the availability of inflation data, performance under the rule is only slightly reduced.

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This chapter was published in:

  • John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 7414.

    Handle: RePEc:nbr:nberch:7414

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    1. Roland Benabou & Jerzy Konieczny, 1993. "On Inflation and Output with Costly Price Changes: A Simple Unifying Result," NBER Technical Working Papers 0135, National Bureau of Economic Research, Inc.
    2. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory, Federal Reserve Bank of San Francisco 95-02, Federal Reserve Bank of San Francisco.
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    7. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
    8. Andrew Levin & Volker Wieland & John C. Williams, 1998. "Robustness of simple monetary policy rules under model uncertainty," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1998-45, Board of Governors of the Federal Reserve System (U.S.).
    9. William Kerr & Robert G. King, 1996. "Limits on interest rate rules in the IS model," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Spr, pages 47-75.
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