Why Are Target Interest Rate Changes So Persistent?

Olivier Coibion, Yuriy Gorodnichenko

NBER Working Paper No. 16707
Issued in January 2011, Revised in December 2011
NBER Program(s):Economic Fluctuations and Growth, International Finance and Macroeconomics, Monetary Economics

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.

Acknowledgments

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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. citation courtesy of

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