Keywords: Monetary policy rules, interest rate smoothing
Abstract: Many researchers have found that the lagged interest rate enters
estimated monetary policy rules with overwhelming significance.
However, a recent paper by Rudebusch (2002) argues that the lagged
interest rate is not a fundamental component of the U.S. policy
rule, and that its significance arises from the omission of
serially correlated variables from the policy rule. This paper
demonstrates that, contrary to Rudebusch's claims, these two
hypotheses can be directly distinguished in the estimation of the
policy rule. Our findings indicate that while serially correlated
omitted variables may be present, the lagged interest rate enters
the policy rule on its own right and plays an important role in
describing the behavior of the federal funds rate.
Full paper (138 KB PDF)
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Last update: May 7, 2002