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Interest Rate Rules and the Response to the Output Gap


  • Juan Paez-Farrell

    (Hull University)


Modern monetary policy analysis is built around the concept of an interest rate rule that responds to both inflation and output. This paper evaluates the quantitative implications of having a policy rule target different definitions of the output gap in a New Keynesian model with endogenous capital. One crucial result is that different model specifications result in alternative values for potential output, raising the issue of which output gap to target. The results of this paper suggest that targeting the true output gap can be well approximated by a rule that only reacts to inflation.

Suggested Citation

  • Juan Paez-Farrell, 2005. "Interest Rate Rules and the Response to the Output Gap," Macroeconomics 0503016, EconWPA.
  • Handle: RePEc:wpa:wuwpma:0503016 Note: Type of Document - pdf; pages: 19

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    References listed on IDEAS

    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.
    2. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    3. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
    4. Yash P. Mehra, 1999. "A forward-looking monetary policy reaction function," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 33-54.
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    More about this item


    Monetary Policy Rules; Output Gap;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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