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Estimated, Calibrated, and Optimal Interest Rate Rules

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Abstract

Estimated, calibrated, and optimal interest rate rules are examined for their ability to dampen economic fluctuations caused by random shocks. A tax rate rule is also considered. The results show that the estimated interest rate rule used in the paper is stable for the period beginning in 1954 except for the early Volcker period, although more observations, especially high inflation ones, are needed before much confidence can be placed on the results. The models used for the stabilization results are large scale structural macroeconometric models, and some of the results differ from those based on small models. For example, rules with inflation coefficients less than one are not destabilizing, and rules with large inflation coefficients, such as the Taylor rule, achieve a small reduction in inflation variability at a cost of a large increase in interest rate variability.

Suggested Citation

  • Ray C. Fair, 2000. "Estimated, Calibrated, and Optimal Interest Rate Rules," Cowles Foundation Discussion Papers 1258, Cowles Foundation for Research in Economics, Yale University.
  • Handle: RePEc:cwl:cwldpp:1258
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    File URL: http://cowles.yale.edu/sites/default/files/files/pub/d12/d1258.pdf
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    References listed on IDEAS

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    7. Fair, Ray C & Taylor, John B, 1983. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 51(4), pages 1169-1185, July.
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    Cited by:

    1. David Rae & David Turner, 2001. "A Small Global Forecasting Model," OECD Economics Department Working Papers 286, OECD Publishing.
    2. 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.
    3. Ray C. Fair, 2001. "Actual Federal Reserve policy behavior and interest rate rules," Economic Policy Review, Federal Reserve Bank of New York, issue Mar, pages 61-72.
    4. Jiri Podpiera, 2006. "The Role of Policy Rule Misspecification in Monetary Policy Inertia Debate," CERGE-EI Working Papers wp315, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    5. Jonathan L. Willis, 2003. "Implications of structural changes in the U.S. economy for pricing behavior and inflation dynamics," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 5-27.

    More about this item

    Keywords

    Interest rate rules; optimal control;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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