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Interest Rate Volatility and Monetary Policy

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  • Carl E. Walsh

Abstract

In October 1979 the Federal Reserve shifted from an interest rate oriented operating procedure to a reserves oriented procedure. It is argued in this paper that part of the very large increase in interest rate volatility which resulted from the policy switch may have been due to shifts in the parameters of the money demand equation, shifts due to the adoption-of a reserve aggregates operating procedure. This result is derived by comparing rational expectations equilibria in a simple theoretical model under alternative policy rules. This allows the variance of interest rates to be explicitly expressed as a function of the policy rule.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0915.

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Date of creation: Jun 1982
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Publication status: published as Walsh, Carl E. "Interest Rate Volatility and Monetary Policy." Journal of Money, Credit and Banking, Vol. 16, No. 2, (May 1984), pp. 133-150.
Handle: RePEc:nbr:nberwo:0915

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  1. William Poole, 1970. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Staff Studies, Board of Governors of the Federal Reserve System (U.S.) 57, Board of Governors of the Federal Reserve System (U.S.).
  2. McCafferty, Stephen & Driskill, Robert, 1980. "Problems of Existence and Uniqueness in Nonlinear Rational Expectations Models," Econometrica, Econometric Society, Econometric Society, vol. 48(5), pages 1313-17, July.
  3. Barro, Robert J, 1980. "A Capital Market in an Equilibrium Business Cycle Model," Econometrica, Econometric Society, Econometric Society, vol. 48(6), pages 1393-1417, September.
  4. McCallum, Bennett T, 1980. "Rational Expectations and Macroeconomic Stabilization Policy: An Overview," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 12(4), pages 716-46, November.
  5. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, Econometric Society, vol. 47(5), pages 1267-86, September.
  6. Feige, Edgar L & McGee, Robert, 1979. "Has the Federal Reserve Shifted from a Policy of Interest Rate Targets to a Policy of Monetary Aggregate Targets?," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 11(4), pages 381-404, November.
  7. Klein, Benjamin, 1977. "The Demand for Quality-adjusted Cash Balances: Price Uncertainty in the U.S. Demand for Money Function," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(4), pages 691-715, August.
  8. McCallum, Bennett T., 1981. "Price level determinacy with an interest rate policy rule and rational expectations," Journal of Monetary Economics, Elsevier, Elsevier, vol. 8(3), pages 319-329.
  9. Taylor, John B, 1975. "Monetary Policy during a Transition to Rational Expectations," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 83(5), pages 1009-21, October.
  10. Weber, Warren E, 1981. "Output Variability under Monetary Policy and Exchange Rate Rules," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 89(4), pages 733-51, August.
  11. Aoki, Masanao & Canzoneri, Matthew, 1979. "Reduced Forms of Rational Expectations Models," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 93(1), pages 59-71, February.
  12. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 1(1), pages 19-46, January.
  13. Barro, Robert J., 1977. "Long-term contracting, sticky prices, and monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 3(3), pages 305-316, July.
  14. Bennett T. McCallum & James G. Hoehn, 1982. "Money stock control with reserve and interest rate instruments under rational expectations," Working Papers, Federal Reserve Bank of Dallas 8201, Federal Reserve Bank of Dallas.
  15. Flood, Robert P, 1979. "Capital Mobility and the Choice of Exchange Rate System," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(2), pages 405-16, June.
  16. John Bryant & Neil Wallace, 1980. "A suggestion for further simplifying the theory of money," Staff Report, Federal Reserve Bank of Minneapolis 62, Federal Reserve Bank of Minneapolis.
  17. Flood, Robert P & Garber, Peter M, 1980. "Market Fundamentals versus Price-Level Bubbles: The First Tests," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(4), pages 745-70, August.
  18. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, Econometric Society, vol. 46(6), pages 1429-45, November.
  19. Benjamin M. Friedman, 1977. "The Inefficiency of Short-Run Monetary Targets for Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 8(2), pages 293-346.
  20. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 2(1), pages 1-32, January.
  21. McCallum, B. T. & Whitaker, J. K., 1979. "The effectiveness of fiscal feedback rules and automatic stabilizers under rational expectations," Journal of Monetary Economics, Elsevier, Elsevier, vol. 5(2), pages 171-186, April.
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Cited by:
  1. Kung, James J., 2009. "A two-asset stochastic model for long-term portfolio selection," Mathematics and Computers in Simulation (MATCOM), Elsevier, Elsevier, vol. 79(10), pages 3089-3098.
  2. John B. Taylor, 1982. "The role of expectations in the choice of monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 47-95.
  3. David F. Hendry & Neil R. Ericsson, 1990. "Modeling the demand for narrow money in the United Kingdom and the United States," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 383, Board of Governors of the Federal Reserve System (U.S.).
  4. Rudebusch, Glenn D, 2005. "Assessing the Lucas Critique in Monetary Policy Models," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 37(2), pages 245-72, April.
  5. Rother, Philipp C., 1998. "European monetary integration and the demand for money," Journal of International Money and Finance, Elsevier, Elsevier, vol. 17(4), pages 691-711, August.
  6. Cunado Eizaguirre, Juncal & Biscarri, Javier Gomez & Hidalgo, Fernando Perez de Gracia, 2004. "Structural changes in volatility and stock market development: Evidence for Spain," Journal of Banking & Finance, Elsevier, Elsevier, vol. 28(7), pages 1745-1773, July.
  7. Goodhart, Charles, 1989. "The Conduct of Monetary Policy," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 99(396), pages 293-346, June.
  8. V. Vance Roley & Carl E. Walsh, 1983. "Monetary Policy Regimes, Expected Inflation, and the Response of Interest Rates to Money Announcements," NBER Working Papers 1181, National Bureau of Economic Research, Inc.
  9. Ira Saltz, 1997. "Federal deposit insurance coverage and bank failures: A cointegration analysis with semi-annual data, 1965–91," Journal of Economics and Finance, Springer, Springer, vol. 21(3), pages 3-9, September.
  10. V. Vance Roley, 1986. "U.S. Monetary Policy Regimes and U.S.-Japan Financial Relations," NBER Working Papers 1858, National Bureau of Economic Research, Inc.

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