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Inertia in Taylor Rules

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Author Info
John Driffill (Department of Economics, Mathematics & Statistics, Birkbeck)
Zeno Rotondi

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Abstract

The inertia found in econometric estimates of interest rate rules is a continuing puzzle. Many reasons for it have been offered, though unsatisfactorily, and the issue remains open. In the empirical literature on interest rate rules, inertia in setting interest rates is typically modeled by specifying a Taylor rule with the lagged policy rate on the right hand side. We argue that inertia in the policy rule may simply reflect the inertia in the economy itself, since optimal rules typically inherit the inertia present in the model of the economy. Our hypothesis receives some support from US data. Hence we agree with Rudebusch (2002) that monetary inertia is, at least partly, an illusion, but for different reasons.

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File URL: http://www.ems.bbk.ac.uk/research/wp/PDF/BWPEF0720.pdf
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Paper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0720.

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Date of creation: Nov 2007
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Handle: RePEc:bbk:bbkefp:0720

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Related research
Keywords: Monetary Policy; Interest Rate Rules; Taylor rule; Interest Rate Smoothing; Monetary Policy Inertia; Predictability of Interest Rates; Term Structure; Expectations Hypothesis;

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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