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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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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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