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American Economic Journal: Macroeconomics: Vol. 4 No. 4 (October 2012)

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Why Are Target Interest Rate Changes So Persistent?

Article Citation

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

DOI: 10.1257/mac.4.4.126

Abstract

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 United States is controversial, with tests of competing hypotheses, such as interest-smoothing and persistent-shocks, 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 between competing explanations of policy inertia. The evidence strongly favors the interest-smoothing explanation and thus can help resolve a key puzzle in monetary economics. (JEL C53, E43, E47, E52, E58)

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Authors

Coibion, Olivier (IMF and U TX)
Gorodnichenko, Yuriy (U CA, Berkeley)

JEL Classifications

C53: Forecasting and Prediction Methods; Simulation Methods
E43: Interest Rates: Determination, Term Structure, and Effects
E47: Money and Interest Rates: Forecasting and Simulation: Models and Applications
E52: Monetary Policy
E58: Central Banks and Their Policies

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American Economic Journal: Macroeconomics


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