Inertia in Taylor Rules

32 Pages Posted: 6 Jun 2008

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

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 modelled 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: expectations hypothesis, Interest Rate Rules, Interest Rate Smoothing, Monetary Policy, Monetary Policy Inertia, Predictability of interest rates, Taylor rule, term structure

JEL Classification: E52, E58

Suggested Citation

Driffill, John and Rotondi, Zeno, Inertia in Taylor Rules. CEPR Discussion Paper No. DP6570, Available at SSRN: https://ssrn.com/abstract=1140097

John Driffill (Contact Author)

University of London - Birkbeck College ( email )

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Centre for Economic Policy Research (CEPR)

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Zeno Rotondi

UNICREDIT ( email )

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ROME, 00186
Italy

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

LUISS Guido Carli University ( email )

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