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Interest Rate Smoothing and Inflation-Output Variabilityin a Small Open Economy

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Author Info
T.C.Y. Kam
G.C. Lim

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Abstract

This paper is concerned with the relationship between the interest rate smoothing behavior of a central bank and the variability of inflation and output. The issue is analyzed through the lens of a small open economy dynamic stochastic general equilibrium model with nontraded goods price rigidities and habit persistence. The benchmark model is calibrated to match certain key business cycle features of a small open economy like Australia. Relative to the benchmark model, experiments on a Taylor rule with interest rate smoothing are conducted. Due to the existence of a short run expectational Phillips curve in the model, monetary policy will imply certain trade-offs between inflation and output variance, under sensible parameter values of the model. More importantly, in a world where there exists such a trade-off, greater interest rate smoothing in the Taylor rule can potentially yield lower sacrifices in terms of output variability in return for lower inflation, thus increasing policy effectiveness.

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Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 817.

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Length: 26 pages
Date of creation: 2001
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Handle: RePEc:mlb:wpaper:817

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Related research
Keywords: Interest rate smoothing; monetary policy; business cycles; stickyprices; habit formation; dynamic stochastic general equilibrium;

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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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. Julián Pérez Amaya, 2006. "Evaluación De Reglas De Tasa De Interés En Un Modelo De Economía Pequeña Y Abierta," BORRADORES DE ECONOMIA 002638, BANCO DE LA REPÚBLICA. [Downloadable!]
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