Interpreting the Significance of the Lagged Interest Rate in Estimated Monetary Policy Rules

27 Pages Posted: 19 Jun 2002

See all articles by William B. English

William B. English

Board of Governors of the Federal Reserve System

William R. Nelson

Board of Governors of the Federal Reserve System

Brian P. Sack

Board of Governors of the Federal Reserve - Monetary and Financial Market Analysis Section

Date Written: May 2002

Abstract

Many researchers have found that the lagged interest rate enters estimated monetary policy rules with overwhelming significance. However, a recent paper by Rudebusch (2002) argues that the lagged interest rate is not a fundamental component of the U.S. policy rule, and that its significance arises from the omission of serially correlated variables from the policy rule. This paper demonstrates that, contrary to Rudebusch's claims, these two hypotheses can be directly distinguished in the estimation of the policy rule. Our findings indicate that while serially correlated omitted variables may be present, the lagged interest rate enters the policy rule on its own right and plays an important role in describing the behavior of the federal funds rate.

Keywords: Monetary policy rules, interest rate smoothing

JEL Classification: E52, E58

Suggested Citation

English, William B. and Nelson, William Richard and Sack, Brian P., Interpreting the Significance of the Lagged Interest Rate in Estimated Monetary Policy Rules (May 2002). Available at SSRN: https://ssrn.com/abstract=314425 or http://dx.doi.org/10.2139/ssrn.314425

William B. English (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Washington, DC 20551
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202-736-5645 (Phone)
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William Richard Nelson

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Brian P. Sack

Board of Governors of the Federal Reserve - Monetary and Financial Market Analysis Section ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-736-5671 (Phone)
202-452-2301 (Fax)

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