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Macroeconomic and interest rate volatility under alternative monetary operating procedures

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  • Petra Gerlach-Kristen
  • Barbara Rudolf

Abstract

During the financial crisis of 2007/08 the level and volatility of interest rate spreads increased dramatically. This paper examines how the choice of the target interest rate for monetary policy affects the volatility of inflation, the output gap and the yield curve. We consider three monetary policy operating procedures with different target interest rates: two market rates with maturities of one and three months, respectively, and an essentially riskless one-month repo rate. The implementation tool is the one-month repo rate for all three operating procedures. In a highly stylised model, we find that using a money market rate as a target rate generally yields lower variability of the macroeconomic variables. This holds under discretion as well as under commitment both in times of financial calm or turmoil. Whether the one month or three month rate procedure performs best depends on the maturity of the specific rate that enters the IS curve.

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Bibliographic Info

Paper provided by Swiss National Bank in its series Working Papers with number 2010-12.

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Length: 49 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:snb:snbwpa:2010-12

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Keywords: Optimal monetary policy rules; monetary operating procedures; yield curve;

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References

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  1. Hans Dewachter & Marco Lyrio, 2003. "Macro Factors and the Term Structure of Interest Rates," International Economics Working Papers Series ces0304, Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics.
  2. Kulish Mariano, 2007. "Should Monetary Policy Use Long-Term Rates?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-26, July.
  3. Kevin J. Lansing & Bharat Trehan, 2003. "Forward-looking behavior and optimal discretionary monetary policy," Working Paper Series 2001-03, Federal Reserve Bank of San Francisco.
  4. Glenn D. Rudebusch & Brian P. Sack & Eric T. Swanson, 2006. "Macroeconomic implications of changes in the term premium," Working Paper Series 2006-46, Federal Reserve Bank of San Francisco.
  5. Lars Svensson & Noah Williams, 2005. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," NBER Working Papers 11733, National Bureau of Economic Research, Inc.
  6. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  7. Sharon Kozicki & P.A. Tinsley, 2007. "Term Structure Transmission of Monetary Policy," Working Papers 07-30, Bank of Canada.
  8. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," Economics Working Papers ECO2011/15, European University Institute.
  9. Peter Hordahl & Oreste Tristani & David Vestin, 2003. "A joint econometric model of macroeconomic and term structure," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  10. Svensson, L.E.O., 1993. "Term, Inflation and Foreign Exchange Risk Premia: A Unified Treatment," Papers 548, Stockholm - International Economic Studies.
  11. Eijffinger, Sylvester C W & Schaling, Eric & Verhagen, Willem, 2000. "The Term Structure of Interest Rates and Inflation Forecast Targeting," CEPR Discussion Papers 2375, C.E.P.R. Discussion Papers.
  12. Dennis, Richard & Söderström, Ulf, 2002. "How Important Is Precommitment for Monetary Policy?," Working Paper Series 139, Sveriges Riksbank (Central Bank of Sweden).
  13. François-Louis Michaud & Christian Upper, 2008. "What drives interbank rates? Evidence from the Libor panel," BIS Quarterly Review, Bank for International Settlements, March.
  14. Monika Piazzesi & Eric T. Swanson, 2006. "Futures prices as risk-adjusted forecasts of monetary policy," Working Paper Series 2006-23, Federal Reserve Bank of San Francisco.
  15. Gerlach-Kristen, Petra & Rudolf, Barbara, 2010. "Financial shocks and the maturity of the monetary policy rate," Economics Letters, Elsevier, vol. 107(3), pages 333-337, June.
  16. McGough, Bruce & Rudebusch, Glenn D. & Williams, John C., 2005. "Using a long-term interest rate as the monetary policy instrument," Journal of Monetary Economics, Elsevier, vol. 52(5), pages 855-879, July.
  17. Christopher Martin & Costas Milas, 2010. "The Sub-Prime Crisis and UK Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 6(3), pages 119-144, September.
  18. 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.
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