Inertia in Taylor Rules

World Economy & Finance Research Programme Working Paper No. WEF 0032

30 Pages Posted: 10 Nov 2007

See all articles by John Driffill

John Driffill

University of London - Birkbeck College; Centre for Economic Policy Research (CEPR)

Zeno Rotondi

UNICREDIT; LUISS Guido Carli University

Multiple version iconThere are 2 versions of this paper

Date Written: November 2007

Abstract

The inertia found in econometric estimates of interest rate rules is a continuing puzzle. Many reasons for it have been offered, though unsatisfactorily, and the issue remains open. In the empirical literature on interest rate rules, inertia in setting interest rates is typically modeled by specifying a Taylor rule with the lagged policy rate on the right hand side. We argue that inertia in the policy rule may simply reflect the inertia in the economy itself, since optimal rules typically inherit the inertia present in the model of the economy. Our hypothesis receives some support from US data. Hence we agree with Rudebusch (2002) that monetary inertia is, at least partly, an illusion, but for different reasons.

Keywords: Monetary Policy, Interest Rate Rules, Taylor rule, Interest Rate Smoothing, Monetary Policy Inertia, Predictability of Interest Rates, Term Structure, Expectations Hypothesis

JEL Classification: E52, E58

Suggested Citation

Driffill, John and Rotondi, Zeno, Inertia in Taylor Rules (November 2007). World Economy & Finance Research Programme Working Paper No. WEF 0032, Available at SSRN: https://ssrn.com/abstract=1028711 or http://dx.doi.org/10.2139/ssrn.1028711

John Driffill (Contact Author)

University of London - Birkbeck College ( email )

London, WC1E 7HX
United Kingdom
+44 20 7631 6417 (Phone)
+44 20 7631 6416 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Zeno Rotondi

UNICREDIT ( email )

VIA SPECCHI 16
ROME, 00186
Italy

HOME PAGE: http://docenti.luiss.it/rotondi

LUISS Guido Carli University ( email )

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Rome, Roma 00100
Italy

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