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The Monetary Policy Committee's reaction function: an exercise in estimation

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  • Charles Goodhart
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    Abstract

    Almost all economists know the story about the (drunk) person searching for his lost wallet in the night under the lamp-post, not because that was the most likely place to have dropped his wallet, but because that was where the light was. I shall argue here that this story is fitting in the case of Taylor-type Central Bank reaction functions. These functions indicate how Central Banks might adjust interest rates in response to deviations of current inflation and current output from some desired level, so that, it = a + b(ðt - ð*) + b2yt + b3it-1 (1) where i is the nominal interest rate, ð the current rate of inflation, y is the estimated output gap, and the final term (b3it-1) is usually included to account for the empirical evidence of auto-correlation in the time path of interest rates.

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    File URL: http://eprints.lse.ac.uk/24708/
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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 24708.

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    Length: 49 pages
    Date of creation: May 2004
    Date of revision:
    Handle: RePEc:ehl:lserod:24708

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    1. Francis X. Diebold & Canlin Li, 2003. "Forecasting the Term Structure of Government Bond Yields," NBER Working Papers 10048, National Bureau of Economic Research, Inc.
    2. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
    3. Carriero, Andrea & Favero, Carlo A & Kaminska, Iryna, 2004. "Financial Factors, Macroeconomic Information and the Expectations Theory of the Term Structure of Interest Rates," CEPR Discussion Papers 4301, C.E.P.R. Discussion Papers.
    4. Klaeffling, Matt & López Pérez, Víctor, 2003. "Inflation targets and the liquidity trap," Working Paper Series 0272, European Central Bank.
    5. Wolfgang Nierhaus & Jan-Egbert Sturm, 2003. "Methoden der Konjunkturprognose," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 56(04), pages 7-23, 02.
    6. Buiter, Willem H, 1984. "Granger-Causality and Policy Effectiveness," Economica, London School of Economics and Political Science, vol. 51(202), pages 151-62, May.
    7. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
    8. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
    9. James Tobin, 1969. "Money and Income: Post Hoc Ergo Propter Hoc?," Cowles Foundation Discussion Papers 283, Cowles Foundation for Research in Economics, Yale University.
    10. Richard Clarida & Jordi Gali & Mark Gertler, 1997. "Monetary Policy Rules in Practice: Some International Evidence," NBER Working Papers 6254, National Bureau of Economic Research, Inc.
    11. 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.
    12. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
    13. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
    14. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
    15. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August.
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    Cited by:
    1. Carlos Montoro, 2007. "Monetary Policy Committees and Interest Rate Smoothing," CEP Discussion Papers dp0780, Centre for Economic Performance, LSE.
    2. Carlos Montoro, 2007. "Why Central Banks Smooth Interest Rates? A Political Economy Explanation," Working Papers 2007-003, Banco Central de Reserva del Perú.

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