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Optimal Interest-Rate Smoothing

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  • Michael Woodford

Abstract

This paper considers the desirability of the observed tendency of central banks to adjust interest rates only gradually in response to changes in economic conditions. It shows, in the context of a simple model of optimizing private-sector behaviour, that assignment of an interest-rate smoothing objective to the central bank may be desirable, even when reduction of the magnitude of interest-rate changes is not a social objective in itself. This is because a response of policy to "irrelevant" lagged variables may be desirable owing to the way it steers private-sector expectations of future policy. Copyright 2003, Wiley-Blackwell.

Suggested Citation

  • Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
  • Handle: RePEc:oup:restud:v:70:y:2003:i:4:p:861-886
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    File URL: http://hdl.handle.net/10.1111/1467-937X.00270
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    References listed on IDEAS

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    4. Lars E.O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters,in: The Inflation-Targeting Debate, pages 19-92 National Bureau of Economic Research, Inc.
    5. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
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    10. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
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    12. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
    13. King, Mervyn, 1997. "Changes in UK monetary policy: Rules and discretion in practice," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 81-97, June.
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    17. Levine, Paul, 1992. "Should Rules Be Simple?," Economic Change and Restructuring, Springer, vol. 25(2), pages 113-138.
    18. Michael Woodford, 2000. "Pitfalls of Forward-Looking Monetary Policy," American Economic Review, American Economic Association, vol. 90(2), pages 100-104, May.
    19. Cook, Timothy & Hahn, Thomas, 1989. "The effect of changes in the federal funds rate target on market interest rates in the 1970s," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 331-351, November.
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