'Wait and See' Monetary Policy

31 Pages Posted: 18 Oct 2015

See all articles by Xiaowen Lei

Xiaowen Lei

Simon Fraser University; Simon Fraser University (SFU)

Michael Tseng

University of Central Florida

Date Written: October 17, 2015

Abstract

This paper develops a model of the optimal timing of interest rate changes. With fixed adjustment costs and ongoing uncertainty, changing the interest rate involves the exercise of an option. Optimal policy therefore has a “wait- and-see” component, which can be quantified using option pricing techniques. We show that increased uncertainty makes the central bank more reluctant to change its target interest rate, and argue that this helps explain recent observed deviations from the Taylor Rule. An optimal wait-and-see policy fits the target interest rates of the Fed and Bank of Canada better than the Taylor rule.

Keywords: Monetary policy, Interest rate inertia, Optimal stopping

JEL Classification: E52, C61

Suggested Citation

Lei, Xiaowen and Lei, Xiaowen and Tseng, Michael, 'Wait and See' Monetary Policy (October 17, 2015). Available at SSRN: https://ssrn.com/abstract=2675600 or http://dx.doi.org/10.2139/ssrn.2675600

Xiaowen Lei (Contact Author)

Simon Fraser University ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada
7788898946 (Phone)

Simon Fraser University (SFU) ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

Michael Tseng

University of Central Florida ( email )

4000 Central Florida Blvd
Orlando, FL 32816-1400
United States

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