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A Case for Interest Rate Inertia in Monetary Policy

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  • Bask, Mikael

    () (Department of Economics)

Abstract

We argue that it is not necessary for the central bank to react to the exchange rate to have a desirable outcome in the economy. Indeed, when the Taylor rule includes contemporaneous data on the variables in the rule, the central bank can disregard from the exchange rate as long as there is enough with interest rate inertia in monetary policy. The reason is that interest rate inertia and a reaction to the current nominal exchange rate change are perfect substitutes in monetary policy. Hence, we give a rationale for the central bank to focus on the interest rate change rather than the interest rate level to have a desirable outcome in the economy, which we define as a determinate rational expectation equilibrium that is stable under least squares learning.

Suggested Citation

  • Bask, Mikael, 2011. "A Case for Interest Rate Inertia in Monetary Policy," Working Paper Series 2011:16, Uppsala University, Department of Economics.
  • Handle: RePEc:hhs:uunewp:2011_016
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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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    Cited by:

    1. Bask, Mikael & Proaño, Christian R., 2016. "Optimal monetary policy under learning and structural uncertainty in a New Keynesian model with a cost channel and inflation inertia," Journal of Economic Dynamics and Control, Elsevier, vol. 69(C), pages 112-126.

    More about this item

    Keywords

    Determinacy; Foreign Exchange; Interest Rate Inertia; Least Squares Learning; Monetary Policy; Taylor Rule;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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