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Interest Rate in the Objective Function of the Central Bank and Monetary Policy Design

Author

Listed:
  • Guy Segal

    (Bank of Israel)

Abstract

We analyze two well-known specifications of the interest rate term in the central bank's objective function, and find that the inflation response to a positive demand shock is positive (intuitive) under one specification and negative (counter-intuitive) under the other. We show that the difference between the two responses can be mitigated by a Taylor-type rule and depends on the interest rate inertia. A super-inertial interest rate, which is more aggressive and leads to the counter-intuitive response, may be helpful in an environment of low inflation due to negative demand shocks, such as the current global economic environment.

Suggested Citation

  • Guy Segal, 2017. "Interest Rate in the Objective Function of the Central Bank and Monetary Policy Design," Bank of Israel Working Papers 2017.02, Bank of Israel.
    • Handle: RePEc:boi:wpaper:2017.02
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    File URL: https://boiwebrepec.azurefd.net/RePEc/boi/wpaper/WP_2017.02.pdf
    File Function: First version, 2017
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    Cited by:

    1. Guy Segal, 2021. "Using Conventional Monetary Policy Unconventionally: Overturning Inflation and Output Gap Dynamics Using a Super-Inertial Interest Rate Rule," Bank of Israel Working Papers 2021.05, Bank of Israel.

    More about this item

    Keywords

    Interest rate smoothing; super inertial; optimal monetary policy;
    All these keywords.

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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