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Why Are Target Interest Rate Changes So Persistent?

  • Olivier Coibion
  • Yuriy Gorodnichenko

While the degree of policy inertia in central banks' reaction functions is a central ingredient in theoretical and empirical monetary economics, the source of the observed policy inertia in the United States is controversial, with tests of competing hypotheses, such as interest-smoothing and persistent-shocks, being inconclusive. This paper employs real time data; nested specifications with flexible time series structures; narratives; interest rate forecasts of the Fed, financial markets, and professional forecasters; and instrumental variables to discriminate between competing explanations of policy inertia. The evidence strongly favors the interest-smoothing explanation and thus can help resolve a key puzzle in monetary economics. (JEL C53, E43, E47, E52, E58)

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/mac.4.4.126
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File URL: http://www.aeaweb.org/aej/mac/data/2011-0185_data.zip
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Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 4 (2012)
Issue (Month): 4 (October)
Pages: 126-62

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Handle: RePEc:aea:aejmac:v:4:y:2012:i:4:p:126-62
Note: DOI: 10.1257/mac.4.4.126
Contact details of provider: Web page: https://www.aeaweb.org/aej-macro
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  21. Olivier Coibion & Yuriy Gorodnichenko, 2010. "Information Rigidity and the Expectations Formation Process: A Simple Framework and New Facts," Working Papers 102, Department of Economics, College of William and Mary.
  22. Olivier Coibion & Yuriy Gorodnichenko, 2011. "Why are target interest rate changes so persistent?," Working Papers 106, Department of Economics, College of William and Mary.
  23. Swanson, Eric T., 2006. "Have Increases in Federal Reserve Transparency Improved Private Sector Interest Rate Forecasts?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(3), pages 791-819, April.
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