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Macroeconomic and interest rate volatility under alternative monetary operating procedures

  • Petra Gerlach-Kristen
  • Barbara Rudolf

During the financial crisis of 2007/08 the level and volatility of interest rate spreads increased dramatically. This paper examines how the choice of the target interest rate for monetary policy affects the volatility of inflation, the output gap and the yield curve. We consider three monetary policy operating procedures with different target interest rates: a one-month market rate, a three-month market rate and an essentially riskless one-month repo rate. The implementation tool is the one-month repo rate for all three operating procedures. In a highly stylised model, we find that using a money market rate as a target rate generally yields lower variability of the macroeconomic variables. This holds under discretion as well as under commitment both in times of financial calm or turmoil. Whether the one month or three month rate procedure performs best depends on the maturity of the specific rate that enters the IS curve.

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Paper provided by Bank for International Settlements in its series BIS Working Papers with number 319.

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Length: 41 pages
Date of creation: Sep 2010
Date of revision:
Handle: RePEc:bis:biswps:319
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  1. Dennis, Richard & Söderström, Ulf, 2002. "How Important Is Precommitment for Monetary Policy?," Working Paper Series 139, Sveriges Riksbank (Central Bank of Sweden).
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  6. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  7. Lansing, Kevin J. & Trehan, Bharat, 2003. "Forward-looking behavior and optimal discretionary monetary policy," Economics Letters, Elsevier, vol. 81(2), pages 249-256, November.
  8. Christopher Martin & Costas Milas, 2008. "The Sub-Prime Crisis and UK Monetary Policy," Working Paper Series 31-08, The Rimini Centre for Economic Analysis, revised Jan 2008.
  9. Svensson, Lars E O & Williams, Noah, 2007. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," CEPR Discussion Papers 6331, C.E.P.R. Discussion Papers.
  10. François-Louis Michaud & Christian Upper, 2008. "What drives interbank rates? Evidence from the Libor panel," BIS Quarterly Review, Bank for International Settlements, March.
  11. Kulish Mariano, 2007. "Should Monetary Policy Use Long-Term Rates?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-26, July.
  12. Gerlach-Kristen, Petra & Rudolf, Barbara, 2010. "Financial shocks and the maturity of the monetary policy rate," Economics Letters, Elsevier, vol. 107(3), pages 333-337, June.
  13. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  14. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," Economics Working Papers ECO2011/15, European University Institute.
  15. Sharon Kozicki & Peter Tinsley, 2005. "Term structure transmission of monetary policy," Research Working Paper RWP 05-06, Federal Reserve Bank of Kansas City.
  16. Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
  17. Svensson, L.E.O., 1993. "Term, Inflation and Foreign Exchange Risk Premia: A Unified Treatment," Papers 548, Stockholm - International Economic Studies.
  18. Peter Hordahl & Oreste Tristani & David Vestin, 2003. "A joint econometric model of macroeconomic and term structure," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  19. McGough, Bruce & Rudebusch, Glenn D. & Williams, John C., 2005. "Using a long-term interest rate as the monetary policy instrument," Journal of Monetary Economics, Elsevier, vol. 52(5), pages 855-879, July.
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