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Interest-Rate Smoothing

  • Robert J. Barro

The paper develops a model in which targeting of the nominal interest rate is a reasonable guide for monetary policy. Expected real interest rates and output are exogenous with respect to monetary variables, and the central bank ends up influencing nominal interest rates by altering expected inflation. In this model the monetary authority can come arbitrarily close in each period to its (time-varying) target for the nominal interest rate, even while holding down the forecast variance of the price level. The latter objective pins down the extent of monetary accommodation to shifts in the demand for money and other shocks, and thereby makes determinate the levels of money and prices at each date. Empirical evidence for the United States in the post-World War II period suggests that the model's predictions accord reasonably well with observed behavior for nominal interest rates, growth rates of the monetary base, and rates of inflation. Earlier periods, especially before World War I, provide an interesting contrast because interest-rate smoothing did not apply. The behavior of the monetary base and the price level at these times differed from the post-World War I1 experience in ways predicted by the theory

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2581.

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Date of creation: May 1988
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Publication status: published as "Interest-Rate Targeting" From Journal of Monetary Economics, Vol. 23, No. 1, pp. 3-30, (January 1989).
Handle: RePEc:nbr:nberwo:2581
Note: EFG ME
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  1. William Poole, 1970. "Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model," The Quarterly Journal of Economics, Oxford University Press, vol. 84(2), pages 197-216.
  2. Mankiw, N. Gregory, 1987. "The optimal collection of seigniorage : Theory and evidence," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 327-341, September.
  3. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
  4. Kimbrough, Kent P., 1986. "The optimum quantity of money rule in the theory of public finance," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 277-284, November.
  5. William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers 2, Board of Governors of the Federal Reserve System (U.S.).
  6. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
  7. Ray C. Fair, 1978. "An Analysis of the Accuracy of Four Macroeconometric Models," Cowles Foundation Discussion Papers 492, Cowles Foundation for Research in Economics, Yale University.
  8. King, Robert G & Plosser, Charles I, 1984. "Money, Credit, and Prices in a Real Business Cycle," American Economic Review, American Economic Association, vol. 74(3), pages 363-80, June.
  9. McCallum, Bennett T., 1981. "Price level determinacy with an interest rate policy rule and rational expectations," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 319-329.
  10. Brunner, Karl & Cukierman, Alex & Meltzer, Allan H., 1980. "Stagflation, persistent unemployment and the permanence of economic shocks," Journal of Monetary Economics, Elsevier, vol. 6(4), pages 467-492, October.
  11. Clark, Truman A, 1986. "Interest Rate Seasonals and the Federal Reserve," Journal of Political Economy, University of Chicago Press, vol. 94(1), pages 76-125, February.
  12. Miron, Jeffrey A, 1986. "Financial Panics, the Seasonality of the Nominal Interest Rate, and theFounding of the Fed," American Economic Review, American Economic Association, vol. 76(1), pages 125-40, March.
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