NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Why Are Target Interest Rate Changes So Persistent?

Olivier Coibion, Yuriy Gorodnichenko

NBER Working Paper No. 16707
Issued in January 2011
NBER Program(s):   EFG   IFM   ME

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.

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This paper was revised on December 5, 2011

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Document Object Identifier (DOI): 10.3386/w16707

Published: Olivier Coibion & Yuriy Gorodnichenko, 2012. "Why Are Target Interest Rate Changes So Persistent?," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(4), pages 126-62, October.

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