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Squeezing the Interest Rate Smoothing Weight with a Hybrid Expectations Model

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  • Efrem Castelnuovo

    (Bocconi University and FEEM)

Abstract

Successful descriptions of the short-term nominal interest rate inertial behavior have frequently been obtained with small scale macro models in which a Central Banker minimizes a loss function containing an argument labelled as interest rate smoothing. The rationale for this argument is not straightforward; indeed, there has been a lively debate about it among academics. In this paper we perform a positive exercise to evaluate the relationship existing between private rational expectations and the interest rate smoothing argument. Our findings strongly support rational expectations as an element capable to remarkably reduce the importance of the interest rate smoothing weight in replicating the observed path of the federal funds rate. However, we find a predominance of adaptive expectations in shaping the future paths of inflation ad output gap. Our results also suggest that the Fed has followed a ’Strict Inflation Targeting’ strategy under Greenspan’s regime.

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Paper provided by EconWPA in its series Macroeconomics with number 0211006.

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Date of creation: 13 Nov 2002
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Handle: RePEc:wpa:wuwpma:0211006

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Keywords: Central Banker; interest rate smoothing; rational expectations; hybrid Phillips curve; hybrid IS curve;

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Cited by:
  1. Paolo Surico, 2004. "Inflation Targeting and Nonlinear Policy Rules: The Case of Asymmetric Preferences (new title: The Fed's monetary policy rule and U.S. inflation: The case of asymmetric preferences)," CESifo Working Paper Series 1280, CESifo Group Munich.
  2. Paolo Surico, 2002. "Inflation Targeting and Nonlinear Policy Rules: the Case of Asymmetric Preferences," Macroeconomics 0210002, EconWPA, revised 09 Dec 2003.
  3. Söderström, Ulf & Söderlind, Paul & Vredin, Anders, 2002. "New-Keynesian Models and Monetary Policy: A Reexamination of the Stylized Facts," Working Paper Series in Economics and Finance 511, Stockholm School of Economics, revised 15 Aug 2003.
  4. Castelnuovo, Efrem, 2003. "Describing the Fed's conduct with Taylor rules: is interest rate smoothing important?," Working Paper Series 0232, European Central Bank.
  5. Efrem Castelnuovo, 2004. "Describing the Fed's conduct with simple Taylor rules: is interest rate smoothing important?," Money Macro and Finance (MMF) Research Group Conference 2003 12, Money Macro and Finance Research Group.
  6. Söderström, Ulf & Söderlind, Paul & Vredin, Anders, 2002. "Can a Calibrated New-Keynesian Model of Monetary Policy Fit the Facts?," Working Paper Series 140, Sveriges Riksbank (Central Bank of Sweden).

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