Why are Target Interest Rate Changes so Persistent?

33 Pages Posted: 12 Jan 2011  

Olivier Coibion

University of Texas at Austin

Yuriy Gorodnichenko

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Multiple version iconThere are 2 versions of this paper

Date Written: January 11, 2011

Abstract

We investigate the source of the high persistence in the Federal Funds Rate relative to the predictions of simple Taylor rules. While much of the literature assumes that this reflects interest-smoothing on the part of monetary policy-makers, an alternative explanation is that it represents persistent monetary policy shocks. Applying real-time data of the Federal Reserve’s macroeconomic forecasts, we document that the empirical evidence strongly favors the interest-smoothing explanation. This result obtains in nested specifications with higher order interest smoothing and persistent shocks, a feature missing in previous work. We also show that policy inertia is present in response to economic fluctuations not driven by exogenous monetary policy shocks. Finally, we argue that the predictability of future interest rates by Greenbook forecasts supports the policy inertia interpretation of historical monetary policy actions.

Keywords: Taylor rules, interest rate smoothing, monetary policy shocks

JEL Classification: E3, E4, E5

Suggested Citation

Coibion, Olivier and Gorodnichenko, Yuriy, Why are Target Interest Rate Changes so Persistent? (January 11, 2011). Available at SSRN: https://ssrn.com/abstract=1738512 or http://dx.doi.org/10.2139/ssrn.1738512

Olivier Coibion

University of Texas at Austin ( email )

Austin, TX 78712
United States

Yuriy Gorodnichenko (Contact Author)

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States

HOME PAGE: http://www.econ.berkeley.edu/~ygorodni/index.htm

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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