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The value of interest rate smoothing : how the private sector helps the Federal Reserve

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Listed:
  • Jeffery D. Amato
  • Thomas Laubach

Abstract

Most central banks conduct monetary policy by setting targets for overnight interest rates. During the 1990s, central banks have tended to move these interest rates in small steps without reversing direction quickly, a practice called interest rate smoothing. For example, the majority of Federal Reserve policy moves in the last decade and a half have come in a sequence of 25 basis point moves, in striking contrast to the early 1980s, when short-term interest rates fluctuated widely. In light of this historical contrast, it is natural to ask whether interest rate smoothing is a desirable way to conduct monetary policy.> Amato and Laubach argue that interest rate smoothing is beneficial because the private sector is forward-looking. The private sector bases its decisions on expectations of the future. Thus, a monetary policy move today will be more effective if it is expected to persist over time. By smoothing interest rates, the size of changes in interest rates required to reduce fluctuations in the economy can be smaller than would otherwise be necessary.

Suggested Citation

  • Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 47-64.
  • Handle: RePEc:fip:fedker:y:1999:i:qiii:p:47-64:n:v.84no.3
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    References listed on IDEAS

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    1. Miron, Jeffrey A, 1986. "Financial Panics, the Seasonality of the Nominal Interest Rate, and theFounding of the Fed," American Economic Review, American Economic Association, vol. 76(1), pages 125-140, March.
    2. Ben S. Bernanke & Julio J. Rotemberg (ed.), 1997. "NBER Macroeconomics Annual 1997," MIT Press Books, The MIT Press, edition 1, volume 1, number 026252242x, January.
    3. Ben S. Bernanke & Julio J. Rotemberg, 1997. "Editorial in "NBER Macroeconomics Annual 1997, Volume 12"," NBER Chapters,in: NBER Macroeconomics Annual 1997, Volume 12, pages 1-6 National Bureau of Economic Research, Inc.
    4. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
    5. Ben S. Bernanke & Julio J. Rotemberg, 1997. "NBER Macroeconomics Annual 1997, Volume 12," NBER Books, National Bureau of Economic Research, Inc, number bern97-1, January.
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