Why are Target Interest Rate Changes so Persistent?

41 Pages Posted: 19 Jan 2011 Last revised: 25 Feb 2023

See all articles by Olivier Coibion

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

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Date Written: January 2011

Abstract

While the degree of policy inertia in central banks' reaction functions is a central ingredient in theoretical and empirical monetary economics, the source of the observed policy inertia in the U.S. is controversial, with tests of competing hypotheses such as interest-smoothing and persistent-shocks theories being inconclusive. This paper employs real time data; nested specifications with flexible time series structures; narratives; interest rate forecasts of the Fed, financial markets, and professional forecasters; and instrumental variables to discriminate competing explanations of policy inertia. The presented evidence strongly favors the interest-smoothing explanation and thus can help resolve a key puzzle in monetary economics.

Suggested Citation

Coibion, Olivier and Gorodnichenko, Yuriy, Why are Target Interest Rate Changes so Persistent? (January 2011). NBER Working Paper No. w16707, Available at SSRN: https://ssrn.com/abstract=1743324

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Yuriy Gorodnichenko

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