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Monetary policy committees and interest rate smoothing

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  • Carlos Montoro
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    Abstract

    We extend the New Keynesian Monetary Policy literature relaxing the assumption that the decisions are taken by a single policymaker, considering instead that monetary policy decisions are taken collectively in a committee. We introduce a Monetary Policy Committee (MPC), whose members have different preferences between output and inflation variability and have to vote on the level of the interest rate. This paper helps to explain interest rate smoothing from a political economy point of view, in which MPC members face a bargaining problem on the level of the interest rate. In this framework, the interest rate is a non-linear reaction function on the lagged interest rate and the expected inflation. This result comes from a political equilibrium in which there is a strategic behaviour of the agenda setter with respect to the rest of the MPC’s members. Our approach can also reproduce both features documented by the empirical evidence on interest rate smoothing: a) the modest response of the interest rate to inflation and output gap; and b) the dependence on lagged interest rate; features that are difficult to reproduce in standard New Keynesian models all together. It also provides a theoretical framework on how disagreement among policymakers can slow down the adjustment on interest rates and on “menu costs” in interest rate decisions. Furthermore, a numerical exercise shows that this inertial behaviour of the interest rate is internalised by the economic agents through an increase in expected inflation.

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    File URL: http://eprints.lse.ac.uk/19752/
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    Bibliographic Info

    Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 19752.

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    Length: 34 pages
    Date of creation: Feb 2007
    Date of revision:
    Handle: RePEc:ehl:lserod:19752

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    Keywords: Monetary Policy Committee; interest rate smoothing; New Keynesian Economics; political economy;

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    1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
    2. Drora Karotkin, 1996. "Justification of the simple majority and chairman rules," Social Choice and Welfare, Springer, vol. 13(4), pages 479-486.
    3. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
    4. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series 1998-03, Board of Governors of the Federal Reserve System (U.S.).
    5. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
    6. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers 1750, C.E.P.R. Discussion Papers.
    7. Riboni, Alessandro & Ruge-Murcia, Francesco, 2008. "The Dynamic (In)efficiency of Monetary Policy by Committee," Economics Papers from University Paris Dauphine 123456789/7716, Paris Dauphine University.
    8. Philip Lowe & Luci Ellis, 1997. "The Smoothing of Official Interest Rates," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
    9. Waller, Christopher J, 1989. "Monetary Policy Games and Central Bank Politics," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 21(4), pages 422-31, November.
    10. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
    11. Hans Gersbach & Volker Hahn, 2008. "Should the individual voting records of central bankers be published?," Social Choice and Welfare, Springer, vol. 30(4), pages 655-683, May.
    12. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, octubre-d.
    13. Jan Marc Berk & Beata K. Bierut, 2003. "Committee Structure and its Implications for Monetary Policy Decision-making," Tinbergen Institute Discussion Papers 03-053/2, Tinbergen Institute.
    14. Riboni, Alessandro, 2010. "Committees as Substitutes for Commitment," Economics Papers from University Paris Dauphine 123456789/7684, Paris Dauphine University.
    15. Gerlach-Kristen Petra, 2004. "Interest-Rate Smoothing: Monetary Policy Inertia or Unobserved Variables?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-19, March.
    16. von Hagen, Jurgen & Suppel, Ralph, 1994. "Central bank constitutions for federal monetary unions," European Economic Review, Elsevier, vol. 38(3-4), pages 774-782, April.
    17. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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