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Why are target interest rate changes so persistent?

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Author Info

  • Olivier Coibion

    () (Department of Economics, College of William and Mary)

  • Yuriy Gorodnichenko

    () (Department of Economics, University of California, Berkeley)

Abstract

We investigate the source of the high persistence in the Federal Funds Rate relative to the predictions of simple Taylor rules. While much of the literature assumes that this reflects interest-smoothing on the part of monetary policy-makers, an alternative explanation is that it represents persistent monetary policy shocks. Applying real-time data of the Federal Reserve’s macroeconomic forecasts, we document that the empirical evidence strongly favors the interestsmoothing explanation. This result obtains in nested specifications with higher order interest smoothing and persistent shocks, a feature missing in previous work. We also show that policy inertia is present in response to economic fluctuations not driven by exogenous monetary policy shocks. Finally, we argue that the predictability of future interest rates by Greenbook forecasts supports the policy inertia interpretation of historical monetary policy actions.

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Bibliographic Info

Paper provided by Department of Economics, College of William and Mary in its series Working Papers with number 106.

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Length: 34 pages
Date of creation: 23 Jan 2011
Date of revision:
Handle: RePEc:cwm:wpaper:106

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Keywords: Taylor rules; interest rate smoothing; monetary policy shocks.;

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  1. Miles S. Kimball & John G. Fernald & Susanto Basu, 2006. "Are Technology Improvements Contractionary?," American Economic Review, American Economic Association, vol. 96(5), pages 1418-1448, December.
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  3. Mark Carlson, 2006. "A brief history of the 1987 stock market crash with a discussion of the Federal Reserve response," Finance and Economics Discussion Series 2007-13, Board of Governors of the Federal Reserve System (U.S.).
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  6. Glenn D. Rudebusch, 2005. "Monetary policy inertia: fact or fiction?," Working Papers in Applied Economic Theory 2005-19, Federal Reserve Bank of San Francisco.
  7. Peter N. Ireland, 2002. "Technology Shocks in the New Keynesian Model," Boston College Working Papers in Economics 536, Boston College Department of Economics.
  8. Nicholas Bloom, 2007. "The Impact of Uncertainty Shocks," NBER Working Papers 13385, National Bureau of Economic Research, Inc.
  9. Olivier Coibion & Yuriy Gorodnichenko, 2008. "Monetary Policy, Trend Inflation and the Great Moderation: An Alternative Interpretation," NBER Working Papers 14621, National Bureau of Economic Research, Inc.
  10. Petra Gerlach-Kristen, 2004. "Interest-Rate Smoothing: Monetary Policy Inertia or Unobserved Variables?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 0(1), pages 3.
  11. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 263-318 National Bureau of Economic Research, Inc.
  12. Timothy Cogley & Giorgio E. Primiceri & Thomas J. Sargent, 2008. "Inflation-Gap Persistence in the U.S," NBER Working Papers 13749, National Bureau of Economic Research, Inc.
  13. Bharat Trehan & Tao Wu, 2004. "Time varying equilibrium real rates and monetary policy analysis," Working Papers in Applied Economic Theory 2004-10, Federal Reserve Bank of San Francisco.
  14. Carrillo, J. & Fève, P. & Matheron, J., 2006. "Monetary Policy Inertia or Persistent Shocks?," Working papers 150, Banque de France.
  15. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  16. Lutz Kilian, 2009. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," American Economic Review, American Economic Association, vol. 99(3), pages 1053-69, June.
  17. Kozicki, Sharon & Tinsley, P.A., 2009. "Perhaps the 1970s FOMC did what it said it did," Journal of Monetary Economics, Elsevier, vol. 56(6), pages 842-855, September.
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Citations

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Cited by:
  1. Michael D. Bauer, 2011. "Nominal interest rates and the news," Working Paper Series 2011-20, Federal Reserve Bank of San Francisco.
  2. Leonardo Melosi, 2012. "Signaling effects of monetary policy," Working Paper Series WP-2012-05, Federal Reserve Bank of Chicago.
  3. Carlos Carvalho & Fernanda Nechio, 2012. "Real exchange rate dynamics in sticky-price models with capital," Working Paper Series 2012-08, Federal Reserve Bank of San Francisco.
  4. Ascari, Guido & Castelnuovo, Efrem & Rossi, Lorenza, 2011. "Calvo vs. Rotemberg in a trend inflation world: An empirical investigation," Journal of Economic Dynamics and Control, Elsevier, vol. 35(11), pages 1852-1867.
  5. Matthias Neuenkirch & Peter Tillmann, 2012. "Inflation Targeting, Credibility and Non-Linear Taylor Rules," MAGKS Papers on Economics 201235, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  6. Nikolay Markov & Carlos de Porres, 2011. "Is the Taylor Rule Nonlinear? Empirical Evidence from a Semi-Parametric Modeling Approach," Research Papers by the Department of Economics, University of Geneva 11052, Département des Sciences Économiques, Université de Genève.

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