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

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  • Goodhart, Charles

Abstract

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.

Suggested Citation

  • Goodhart, Charles, 2004. "The Monetary Policy Committee's reaction function: an exercise in estimation," LSE Research Online Documents on Economics 24708, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:24708
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    References listed on IDEAS

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    1. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
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    5. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September.
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    12. Klaeffling, Matt & López Pérez, Víctor, 2003. "Inflation targets and the liquidity trap," Working Paper Series 272, European Central Bank.
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    Cited by:

    1. Montoro, Carlos, 2007. "Monetary policy committees and interest rate smoothing," LSE Research Online Documents on Economics 19752, London School of Economics and Political Science, LSE Library.
    2. Carlos Montoro, 2007. "Why Central Banks Smooth Interest Rates? A Political Economy Explanation," Working Papers 2007-003, Banco Central de Reserva del Perú.

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    JEL classification:

    • J1 - Labor and Demographic Economics - - Demographic Economics

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