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Inertia in Taylor Rules

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  • Driffill, John
  • Rotondi, Zeno

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 modelled 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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6570.

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Date of creation: Nov 2007
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Handle: RePEc:cpr:ceprdp:6570

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Keywords: expectations hypothesis; Interest Rate Rules; Interest Rate Smoothing; Monetary Policy; Monetary Policy Inertia; Predictability of interest rates; Taylor rule; term structure;

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Cited by:
  1. Alessandro Flamini & Andrea Fracasso, 2009. "Household’s Preferences and Monetary Policy Inertia," Working Papers 2009002, The University of Sheffield, Department of Economics, revised Feb 2009.

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