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The Learning Cost of Interest Rate Reversals

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Author Info
Ellison, Martin

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Abstract

In this Paper, we suggest a new motivation for why central banks appear averse to reversing recent changes in their interest rate. We show, in a standard monetary model with forward-looking expectations, data uncertainty and parameter uncertainty, that there is a learning cost associated with interest rate reversals. A policy that frequently reverses the interest rate makes it more difficult for the central bank and private agents to learn the key parameters of the model. Optimal monetary policy internalizes this learning cost and therefore has a lower number of interest rate reversals. The incentive to reduce the number of interest rate reversals is in addition to the optimal policy inertia created by the presence of forward-looking expectations and uncertainty in the model.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4135.

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Date of creation: Dec 2003
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Handle: RePEc:cpr:ceprdp:4135

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Related research
Keywords: interest rate smoothing; learning; monetary policy;

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Find related papers by JEL classification:
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
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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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Bennett T. McCallum & Edward Nelson, 2000. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," NBER Working Papers 5875, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Den Haan, Wouter J & Marcet, Albert, 1994. "Accuracy in Simulations," Review of Economic Studies, Blackwell Publishing, vol. 61(1), pages 3-17, January. [Downloadable!] (restricted)
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  3. Sack, Brian & Wieland, Volker, 2000. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 205-228. [Downloadable!] (restricted)
    Other versions:
  4. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc. [Downloadable!]
  5. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics. [Downloadable!]
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  6. den Haan, Wouter J & Marcet, Albert, 1990. "Solving the Stochastic Growth Model by Parameterizing Expectations," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 31-34, January.
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  7. Volker Wieland, 1996. "Learning by doing and the value of optimal experimentation," Finance and Economics Discussion Series 96-5, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  8. Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series 1998-50, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  9. Rosal, Joao Mauricio & Spagat, Michael, 2002. "Structural Uncertainty and Central Bank Conservatism: The Ignorant Should Keep Their Eyes Shut," CEPR Discussion Papers 3568, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  10. Ellison, Martin & Valla, Natacha, 2001. "Learning, uncertainty and central bank activism in an economy with strategic interactions," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 153-171, August. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Volker Wieland, 2008. "Learning, Endogenous Indexation and Disinflation in the New-Keynesian Model," CFS Working Paper Series 2008/17, Center for Financial Studies. [Downloadable!]
    Other versions:
  2. Tesfaselassie, M.F. & Schaling, E. & Eijffinger, S.C.W., 2006. "Learning About the Term Structure and Optimal Rules for Inflation Targeting," Research Paper ERS-2006-058-F&A Revision, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni. [Downloadable!]
    Other versions:
  3. Lars E.O. Svensson & Noah Williams, 2008. "Optimal monetary policy under uncertainty: a Markov jump-linear-quadratic approach," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 275-294. [Downloadable!]
  4. Lars E.O. Svensson & Noah Williams, 2008. "Optimal Monetary Policy Under Uncertainty in DSGE Models: A Markov Jump-Linear-Quadratic Approach," Working Papers Central Bank of Chile 484, Central Bank of Chile. [Downloadable!]
    Other versions:
  5. Mewael F. Tesfaselassie, 2008. "Central Bank Learning and Monetary Policy," Kiel Working Papers 1444, Kiel Institute for the World Economy. [Downloadable!]
  6. Marcelo Sánchez, 2009. "Characterising the inflation targeting regime in South Korea," Working Paper Series 1004, European Central Bank. [Downloadable!]
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