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Overnight Monetary Policy in the United States: Active or Interest-Rate Smoothing?

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    Abstract

    This paper investigates the behavior of agents in the United States money and Fed funds markets for the period 1982-2004. It was found that, while agents are forward looking in the money market, their behavior is policy invariant in the Fed funds market. Consequently, the optimal overnight monetary policy would be an interest-ratesmoothing process. It was found, in fact, that such a policy has been followed in the United States. Furthermore, this paper suggests that the lack of a policy invariant relationship between overnight and short-term interest rates is another explanation for conducting an interest-rate-smoothing policy.

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    File URL: http://www.carleton.ca/economics/wp-content/uploads/cep05-07.pdf
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    Bibliographic Info

    Paper provided by Carleton University, Department of Economics in its series Carleton Economic Papers with number 05-07.

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    Length: 51 pages
    Date of creation: Jul 2005
    Date of revision: Mar 2010
    Publication status: Published: in Journal of Macroeconomics, Vol. 32, No. 1 (March 2010), pp. 378–391
    Handle: RePEc:car:carecp:05-07

    Note: JEL codes: E43, E51, E52, E58
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    Related research

    Keywords: Interest-rate smoothing; discretionary overnight monetary policy; forward-looking agents; money market; and Fed funds market.;

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    1. Banerjee, A & Hendry, D-F & Mizon, G-E, 1996. "The Econometric Analysis of Economic Policy," Economics Working Papers, European University Institute eco96/34, European University Institute.
    2. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, Econometric Society, vol. 48(4), pages 817-38, May.
    3. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco.
    4. Z. Psaradakis & M. Solá, 1993. "On the power of tests for superexogeneity and structural invariance," Documentos de Trabajo (working papers), Department of Economics - dECON 0993, Department of Economics - dECON.
    5. Carl Walsh, 2003. "Speed Limit Policies: The Output Gap and Optimal Monetary Policy," American Economic Review, American Economic Association, American Economic Association, vol. 93(1), pages 265-278, March.
    6. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2139, C.E.P.R. Discussion Papers.
    7. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, Elsevier, vol. 35(2), pages 245-274, April.
    8. Bennett T. McCallum & Edward Nelson, 1999. "Performance of Operational Policy Rules in an Estimated Semiclassical Structural Model," NBER Chapters, in: Monetary Policy Rules, pages 15-56 National Bureau of Economic Research, Inc.
    9. Hendry, David F & Ericsson, Neil R, 1991. "An Econometric Analysis of U.K. Money Demand in 'Monetary Trends in the United States and the United Kingdom' by Milton Friedman and Anna Schwartz," American Economic Review, American Economic Association, American Economic Association, vol. 81(1), pages 8-38, March.
    10. Brian Sack & Volker Wieland, 1999. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1999-39, Board of Governors of the Federal Reserve System (U.S.).
    11. Ben S. Bernanke & Jean Boivin, 2001. "Monetary Policy in a Data-Rich Environment," NBER Working Papers 8379, National Bureau of Economic Research, Inc.
    12. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
    13. Fair, Ray C, 1978. "The Sensitivity of Fiscal Policy Effects to Assumptions about the Behavior of the Federal Reserve," Econometrica, Econometric Society, Econometric Society, vol. 46(5), pages 1165-79, September.
    14. Engle, R. & Hendry, D., 1990. "Testing Super Exogeneity And Invariance In Regression Models," Economics Series Working Papers 99100, University of Oxford, Department of Economics.
    15. Marvin Goodfriend, 1987. "Interest rate smoothing and price level trend-stationarity," Working Paper, Federal Reserve Bank of Richmond 87-03, Federal Reserve Bank of Richmond.
    16. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, Econometric Society, vol. 50(4), pages 987-1007, July.
    17. Amir Kia, 2003. "Forward-looking agents and macroeconomic determinants of the equity price in a small open economy," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 13(1), pages 37-54.
    18. Cook, Timothy & Hahn, Thomas, 1988. "The Information Content of Discount Rate Announcements and Their Effect on Market Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 20(2), pages 167-80, May.
    19. Smith, R. Todd & van Egteren, Henry, 2005. "Interest rate smoothing and financial stability," Review of Financial Economics, Elsevier, Elsevier, vol. 14(2), pages 147-171.
    20. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
    21. Sarno, Lucio & Thornton, Daniel L, 2002. "The Dynamic Relationship Between the Federal Funds rate and the Treasury Bill Rate: An Empirical Investigation," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3225, C.E.P.R. Discussion Papers.
    22. Granger, C. W. J., 1988. "Some recent development in a concept of causality," Journal of Econometrics, Elsevier, Elsevier, vol. 39(1-2), pages 199-211.
    23. Hansen, Bruce E., 1992. "Testing for parameter instability in linear models," Journal of Policy Modeling, Elsevier, Elsevier, vol. 14(4), pages 517-533, August.
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