Why Are Target Interest Rate Changes So Persistent?
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.
We are grateful to Frederic Mishkin and Glenn Rudebusch for helpful comments and Peter Ireland, Giorgio Primiceri, and Glenn Rudebusch for sharing their data with us. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
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