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The Role of Policy Rule Misspecification in Monetary Policy Inertia Debate

  • Jiri Podpiera

Operational monetary policy rules are characterized by a parsimonious specification and are therefore prone to specification error when estimated on real data. I devise a policy rule estimation procedure, which is robust to marginal misspecification, and study the effects of specification error in least squares. I find the robust evidence of upward bias in policy inertia in least squares applied to most commonly used Taylor type rule. In effect, least squares learning of a central bank can lead to increasing monetary policy inertia over time.

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Paper provided by The Center for Economic Research and Graduate Education - Economics Institute, Prague in its series CERGE-EI Working Papers with number wp315.

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Date of creation: Dec 2006
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Handle: RePEc:cer:papers:wp315
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  1. McCallum, B.T. & Nelson, E., 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Papers 644, Stockholm - International Economic Studies.
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  9. Ray C. Fair, 2000. "Estimated, Calibrated, and Optimal Interest Rate Rules," Cowles Foundation Discussion Papers 1258, Cowles Foundation for Research in Economics, Yale University.
  10. Marie Musard-Gies, 2005. "Do ECB's statements steer short-term and long-term interest rates in the euro zone?," Money Macro and Finance (MMF) Research Group Conference 2005 56, Money Macro and Finance Research Group.
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