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Macroeconomic and interest rate volatility under alternative monetary operating procedures

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  • Petra Gerlach-Kristen
  • Barbara Rudolf

Abstract

During the financial crisis of 2007/08 the level and volatility of interest rate spreads increased dramatically. This paper examines how the choice of the target interest rate for monetary policy affects the volatility of inflation, the output gap and the yield curve. We consider three monetary policy operating procedures with different target interest rates: a one-month market rate, a three-month market rate and an essentially riskless one-month repo rate. The implementation tool is the one-month repo rate for all three operating procedures. In a highly stylised model, we find that using a money market rate as a target rate generally yields lower variability of the macroeconomic variables. This holds under discretion as well as under commitment both in times of financial calm or turmoil. Whether the one month or three month rate procedure performs best depends on the maturity of the specific rate that enters the IS curve.

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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 319.

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Length: 41 pages
Date of creation: Sep 2010
Date of revision:
Handle: RePEc:bis:biswps:319

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Keywords: optimal monetary policy rules; monetary operating procedures; yield curve;

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  1. Svensson, Lars E. O. & Williams, Noah, 2005. "Monetary policy with model uncertainty: distribution forecast targeting," Discussion Paper Series 1: Economic Studies 2005,35, Deutsche Bundesbank, Research Centre.
  2. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," CEP Discussion Papers dp1055, Centre for Economic Performance, LSE.
  3. Gerlach-Kristen, Petra & Rudolf, Barbara, 2010. "Financial shocks and the maturity of the monetary policy rate," Economics Letters, Elsevier, Elsevier, vol. 107(3), pages 333-337, June.
  4. Richard Dennis & Ulf Soderstrom, 2002. "How important is precommitment for monetary policy?," Working Paper Series, Federal Reserve Bank of San Francisco 2002-10, Federal Reserve Bank of San Francisco.
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  14. Lars E.O. Svensson, 1993. "Term, Inflation, and Foreign Exchange Risk Premia: A Unified Treatment," NBER Working Papers 4544, National Bureau of Economic Research, Inc.
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  16. Lansing, Kevin J. & Trehan, Bharat, 2003. "Forward-looking behavior and optimal discretionary monetary policy," Economics Letters, Elsevier, Elsevier, vol. 81(2), pages 249-256, November.
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