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Why are target interest rate changes so persistent?

  • Olivier Coibion

    ()

    (Department of Economics, College of William and Mary)

  • Yuriy Gorodnichenko

    ()

    (Department of Economics, University of California, Berkeley)

We investigate the source of the high persistence in the Federal Funds Rate relative to the predictions of simple Taylor rules. While much of the literature assumes that this reflects interest-smoothing on the part of monetary policy-makers, an alternative explanation is that it represents persistent monetary policy shocks. Applying real-time data of the Federal Reserve’s macroeconomic forecasts, we document that the empirical evidence strongly favors the interestsmoothing explanation. This result obtains in nested specifications with higher order interest smoothing and persistent shocks, a feature missing in previous work. We also show that policy inertia is present in response to economic fluctuations not driven by exogenous monetary policy shocks. Finally, we argue that the predictability of future interest rates by Greenbook forecasts supports the policy inertia interpretation of historical monetary policy actions.

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Paper provided by Department of Economics, College of William and Mary in its series Working Papers with number 106.

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Length: 34 pages
Date of creation: 23 Jan 2011
Date of revision:
Handle: RePEc:cwm:wpaper:106
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  4. Olivier Coibion & Yuriy Gorodnichenko, 2008. "Monetary Policy, Trend Inflation and the Great Moderation: An Alternative Interpretation," NBER Working Papers 14621, National Bureau of Economic Research, Inc.
  5. Julio Carrillo & Patrick Fève & Julien Matheron, 2007. "Monetary Policy Inertia or Persistent Shocks: A DSGE Analysis," International Journal of Central Banking, International Journal of Central Banking, vol. 3(2), pages 1-38, June.
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  9. Andrew Ang & Geert Bekaert & Min Wei, 2006. "Do macro variables, asset markets, or surveys forecast inflation better?," Finance and Economics Discussion Series 2006-15, Board of Governors of the Federal Reserve System (U.S.).
  10. Consolo, Agostino & Favero, Carlo A., 2009. "Monetary Policy Inertia: More a Fiction than a fact?," CEPR Discussion Papers 7341, C.E.P.R. Discussion Papers.
  11. Peter N. Ireland, 2004. "Technology Shocks in the New Keynesian Model," The Review of Economics and Statistics, MIT Press, vol. 86(4), pages 923-936, November.
  12. Olivier Coibion & Yuriy Gorodnichenko, 2008. "What Can Survey Forecasts Tell Us About Informational Rigidities?," NBER Working Papers 14586, National Bureau of Economic Research, Inc.
  13. Leonardo Melosi, 2013. "Signaling Effects of Monetary Policy," PIER Working Paper Archive 13-029, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
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  16. English William B. & Nelson William R. & Sack Brian P., 2003. "Interpreting the Significance of the Lagged Interest Rate in Estimated Monetary Policy Rules," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-18, April.
  17. Kilian, Lutz, 2006. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," CEPR Discussion Papers 5994, C.E.P.R. Discussion Papers.
  18. Peter N. Ireland, 2010. "A New Keynesian Perspective on the Great Recession," NBER Working Papers 16420, National Bureau of Economic Research, Inc.
  19. Gerlach-Kristen Petra, 2004. "Interest-Rate Smoothing: Monetary Policy Inertia or Unobserved Variables?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-19, March.
  20. Beaudry, Paul & Portier, Franck, 2003. "Stock Prices, News and Economic Fluctuations," IDEI Working Papers 158, Institut d'Économie Industrielle (IDEI), Toulouse.
  21. Olivier Coibion & Yuriy Gorodnichenko, 2011. "Why Are Target Interest Rate Changes So Persistent?," NBER Working Papers 16707, National Bureau of Economic Research, Inc.
  22. Kozicki, Sharon & Tinsley, P.A., 2009. "Perhaps the 1970s FOMC did what it said it did," Journal of Monetary Economics, Elsevier, vol. 56(6), pages 842-855, September.
  23. Olivier Coibion & Yuriy Gorodnichenko, 2012. "Information Rigidity and the Expectations Formation Process; A Simple Framework and New Facts," IMF Working Papers 12/296, International Monetary Fund.
  24. Bharat Trehan & Tao Wu, 2004. "Time varying equilibrium real rates and monetary policy analysis," Working Paper Series 2004-10, Federal Reserve Bank of San Francisco.
  25. Mark Carlson, 2006. "A brief history of the 1987 stock market crash with a discussion of the Federal Reserve response," Finance and Economics Discussion Series 2007-13, Board of Governors of the Federal Reserve System (U.S.).
  26. Athanasios Orphanides, 2003. "Historical monetary policy analysis and the Taylor rule," Finance and Economics Discussion Series 2003-36, Board of Governors of the Federal Reserve System (U.S.).
  27. Swanson, Eric T., 2006. "Have Increases in Federal Reserve Transparency Improved Private Sector Interest Rate Forecasts?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(3), pages 791-819, April.
  28. Nicholas Bloom, 2007. "The Impact of Uncertainty Shocks," NBER Working Papers 13385, National Bureau of Economic Research, Inc.
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