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Household’s Preferences and Monetary Policy Inertia

  • Alessandro Flamini


    (Department of Economics, The University of Sheffield)

  • Andrea Fracasso

The estimation of monetary policy rules suggests that the interest rates set by central banks move with a certain inertia. Although a number of hypotheses have been suggested to explain this phenomenon, its ultimate origin is unclear, thus delineating this issue as a modern "puzzle" in monetary economics. We show that household's preferences can play an important role in determining optimal interest rate inertia. Importantly, this can occur even when the central bank has negligible preferences for smoothing the interest rate.

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Paper provided by The University of Sheffield, Department of Economics in its series Working Papers with number 2009002.

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Length: 25 pages
Date of creation: Feb 2009
Date of revision: Feb 2009
Handle: RePEc:shf:wpaper:2009002
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  1. Söderström, Ulf & Söderlind, Paul & Vredin, Anders, 2002. "New-Keynesian Models and Monetary Policy: A Reexamination of the Stylized Facts," SSE/EFI Working Paper Series in Economics and Finance 511, Stockholm School of Economics, revised 15 Aug 2003.
  2. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  3. John Driffill & Zeno Rotondi, 2007. "Inertia in Taylor Rules," WEF Working Papers 0032, ESRC World Economy and Finance Research Programme, Birkbeck, University of London.
  4. Castelnuovo Efrem, 2006. "The Fed's Preference for Policy Rate Smoothing: Overestimation Due to Misspecification?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 6(2), pages 1-22, August.
  5. Brian P. Sack & Volker W. 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.).
  6. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  7. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 861-886, October.
  8. Glenn D. Rudebusch, 2006. "Monetary Policy Inertia: Fact or Fiction?," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.
  9. Alessandro Flamini & Andrea Fracasso, 2009. "Household’s Preferences and Monetary Policy Inertia," Working Papers 2009002, The University of Sheffield, Department of Economics, revised Feb 2009.
  10. Masakatsu Okubo, 2008. "On the Intertemporal Elasticity of Substitution under Nonhomothetic Utility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(5), pages 1065-1072, 08.
  11. Luisa Corrado & Sean Holly, 2004. " Habit Formation and Interest Rate Smoothing," CDMA Conference Paper Series 0404, Centre for Dynamic Macroeconomic Analysis.
  12. Cinzia Alcidi & Alessandro Flamini & Andrea Fracasso, 2011. "Policy Regime Changes, Judgment and Taylor rules in the Greenspan Era," Economica, London School of Economics and Political Science, vol. 78(309), pages 89-107, January.
  13. Alessandro Flamini, 2004. "Inflation Targeting and Exchange Rate Pass-Through," IHEID Working Papers 04-2004, Economics Section, The Graduate Institute of International Studies.
  14. Efrem Castelnuovo, 2004. "Taylor rules, omitted variables, and interest rate smoothing in the US," Macroeconomics 0403009, EconWPA.
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