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The Monetary Policy Committee's reaction function: an exercise in estimation

  • Charles Goodhart
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    Almost all economists know the story about the (drunk) person searching for his lost wallet in the night under the lamp-post, not because that was the most likely place to have dropped his wallet, but because that was where the light was. I shall argue here that this story is fitting in the case of Taylor-type Central Bank reaction functions. These functions indicate how Central Banks might adjust interest rates in response to deviations of current inflation and current output from some desired level, so that, it = a + b(ðt - ð*) + b2yt + b3it-1 (1) where i is the nominal interest rate, ð the current rate of inflation, y is the estimated output gap, and the final term (b3it-1) is usually included to account for the empirical evidence of auto-correlation in the time path of interest rates.

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    File URL: http://eprints.lse.ac.uk/24708/
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    Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 24708.

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    Length: 49 pages
    Date of creation: May 2004
    Date of revision:
    Handle: RePEc:ehl:lserod:24708
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    Web page: http://www.lse.ac.uk/

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    1. Wolfgang Nierhaus & Jan-Egbert Sturm, 2003. "Methoden der Konjunkturprognose," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 56(04), pages 7-23, 02.
    2. Sack, Brian, 2000. "Does the fed act gradually? A VAR analysis," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 229-256, August.
    3. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
    4. Diebold, Francis X. & Li, Canlin, 2003. "Forecasting the term structure of government bond yields," CFS Working Paper Series 2004/09, Center for Financial Studies (CFS).
    5. Klaeffling, Matt & López Pérez, Víctor, 2003. "Inflation targets and the liquidity trap," Working Paper Series 0272, European Central Bank.
    6. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series 1998-03, Board of Governors of the Federal Reserve System (U.S.).
    7. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
    8. Brian Sack & Volker 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.).
    9. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
    10. Andrea Carriero & Carlo Favero & Iryna Kaminska, 2004. "Financial Factors, Macroeconomic Information and the Expectations Theory of the Term Structure of Interest Rates," Working Papers 253, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    11. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
    12. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
    13. Tobin, James, 1970. "Money and Income: Post Hoc Ergo Propter Hoc?," The Quarterly Journal of Economics, MIT Press, vol. 84(2), pages 301-17, May.
    14. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
    15. Buiter, Willem H, 1984. "Granger-Causality and Policy Effectiveness," Economica, London School of Economics and Political Science, vol. 51(202), pages 151-62, May.
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