Interpreting the Significance of the Lagged Interest Rate in Estimated Monetary Policy Rules
Many researchers have found that the lagged interest rate enters estimated monetary policy rules with overwhelming significance, suggesting that policy adjusts gradually to changes in economic conditions. However, Rudebusch (2002) argues that the lagged interest rate is not a fundamental component of the U.S. policy rule, and that its significance arises from the omission of serially correlated variables from the policy rule. This paper considers the possibility that policy rules may be characterized by both partial adjustment and serially correlated omitted variables. Our findings indicate that even if one allows for serially correlated errors, partial adjustment plays an important role in describing the behavior of the federal funds rate.
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Volume (Year): 3 (2003)
Issue (Month): 1 (April)
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