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Interest-Rate Smoothing

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  • Robert J. Barro

Abstract

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

Suggested Citation

  • Robert J. Barro, 1988. "Interest-Rate Smoothing," NBER Working Papers 2581, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:2581
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    Cited by:

    1. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1989. "The Size and Incidence of the Losses from Noise Trading," Journal of Finance, American Finance Association, vol. 44(3), pages 681-696, July.
    2. Nouriel Roubini, 1988. "Offset and Sterilization Under Fixed Exchange Rates With An Optimizing Central Bank," NBER Working Papers 2777, National Bureau of Economic Research, Inc.
    3. Carl E. Walsh, 1987. "The Impact of Monetary Targeting in the United States: 1976-1984," NBER Working Papers 2384, National Bureau of Economic Research, Inc.
    4. Barsky, Robert B. & Mankiw, N. Gregory & Miron, Jeffrey A. & Weill, David N., 1988. "The worldwide change in the behavior of interest rates and prices in 1914," European Economic Review, Elsevier, vol. 32(5), pages 1123-1147, June.
    5. Brian P. Sack, 1998. "Uncertainty, learning, and gradual monetary policy," Finance and Economics Discussion Series 1998-34, Board of Governors of the Federal Reserve System (U.S.).

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