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Overnight Monetary Policy in the United States: Active or Interest-Rate Smoothing?

This paper investigates the behavior of agents in the United States money and Fed funds markets for the period 1982-2004. It was found that, while agents are forward looking in the money market, their behavior is policy invariant in the Fed funds market. Consequently, the optimal overnight monetary policy would be an interest-ratesmoothing process. It was found, in fact, that such a policy has been followed in the United States. Furthermore, this paper suggests that the lack of a policy invariant relationship between overnight and short-term interest rates is another explanation for conducting an interest-rate-smoothing policy.

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File URL: http://www.carleton.ca/economics/wp-content/uploads/cep05-07.pdf
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Paper provided by Carleton University, Department of Economics in its series Carleton Economic Papers with number 05-07.

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Length: 51 pages
Date of creation: Jul 2005
Date of revision: Mar 2010
Publication status: Published: in Journal of Macroeconomics, Vol. 32, No. 1 (March 2010), pp. 378–391
Handle: RePEc:car:carecp:05-07
Note: JEL codes: E43, E51, E52, E58
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  1. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  2. Ray C. Fair, 1977. "The Sensitivity of Fiscal-Policy Effects to Assumptions about the Behavior of the Federal Reserve," Cowles Foundation Discussion Papers 446, Cowles Foundation for Research in Economics, Yale University.
  3. Brian P. Sack & Volker W. Wieland, 1999. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Finance and Economics Discussion Series 1999-39, Board of Governors of the Federal Reserve System (U.S.).
  4. Banerjee, A & Hendry, D-F & Mizon, G-E, 1996. "The Econometric Analysis of Economic Policy," Economics Working Papers eco96/34, European University Institute.
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  8. Smith, R. Todd & van Egteren, Henry, 2005. "Interest rate smoothing and financial stability," Review of Financial Economics, Elsevier, vol. 14(2), pages 147-171.
  9. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
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  13. Hansen, Bruce E., 1992. "Testing for parameter instability in linear models," Journal of Policy Modeling, Elsevier, vol. 14(4), pages 517-533, August.
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  17. Engle, R. & Hendry, D., 1990. "Testing Super Exogeneity And Invariance In Regression Models," Economics Series Working Papers 99100, University of Oxford, Department of Economics.
  18. Alvaro Escribano & Santiago Mira, 2001. "Nonlinear error correction models," Documentos de trabajo conjunto ULL-ULPGC 2001-03, Facultad de Ciencias Económicas de la ULPGC.
  19. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
  20. Z. Psaradakis & M. Solá, 1993. "On the power of tests for superexogeneity and structural invariance," Documentos de Trabajo (working papers) 0993, Department of Economics - dECON.
  21. Ben S. Bernanke & Jean Boivin, 2001. "Monetary Policy in a Data-Rich Environment," NBER Working Papers 8379, National Bureau of Economic Research, Inc.
  22. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
  23. Cook, Timothy & Hahn, Thomas, 1988. "The Information Content of Discount Rate Announcements and Their Effect on Market Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(2), pages 167-80, May.
  24. Hendry, David F & Ericsson, Neil R, 1991. "An Econometric Analysis of U.K. Money Demand in 'Monetary Trends in the United States and the United Kingdom' by Milton Friedman and Anna Schwartz," American Economic Review, American Economic Association, vol. 81(1), pages 8-38, March.
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