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Discrete monetary policy changes and changing inflation targets in estimated dynamic stochastic general equilibrium models

  • Anatoliy Belaygorod
  • Michael J. Dueker

Many estimated macroeconomic models assume interest rate smoothing in the monetary policy equation. In practice, monetary policymakers adjust a target level for the federal funds rate by discrete increments. One often-neglected consequence of using a quarterly average of the daily federal funds rate in empirical work is that any change in the target federal funds rate will affect the quarterly average in the current quarter and the subsequent quarter. Despite this clear source of predictable change in the quarterly average of the federal funds rate, the vast bulk of the literature that estimates policy rules ignores information concerning the timing and magnitude of discrete changes to the target federal funds rate. Consequently, policy equations that include interest rate smoothing inadvertently make the strong and unnecessary assumption that the starting point for interest rate smoothing is last quarter's average level of the federal funds rate. The authors consider, within an estimated general equilibrium model, whether policymakers put weight on the end-of-quarter target level of the federal funds rate when choosing a point at which to smooth the interest rate.

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Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2005)
Issue (Month): Nov ()
Pages: 719-34

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Handle: RePEc:fip:fedlrv:y:2005:i:nov:p:719-34:n:v.87no.6
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