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Policy Irreversibility and Interest Rate Smoothing

  • Teruyoshi Kobayashi
Published/Copyright: October 18, 2010
The B.E. Journal of Macroeconomics
From the journal The B.E. Journal of Macroeconomics Volume 10 Issue 1

Many empirical studies argue that the inertial behavior of policy rates in industrialized countries can be well explained by a linear partial adjustment version of the Taylor rule. However, the explanatory power of the lagged interest rate has been questioned from various points of view. This paper formally examines a situation in which a central bank has an aversion to frequent policy reversals. Imposing an irreversibility constraint on the control space makes the lagged interest rate a state variable. However, the policy function cannot then be expressed as a partial adjustment form, even if the original Taylor rule would be the correct policy function in the absence of the irreversibility constraint. The simulation results reveal that conventional regression tends to falsely support the functionally misspecified partial adjustment model. This implies that the significant role of the lagged interest may simply reflect the central banks’ aversion to policy reversal.

Keywords: gradualism; interest rate smoothing; irreversibility; Taylor rule
Published Online: 2010-10-18

©2011 Walter de Gruyter GmbH & Co. KG, Berlin/Boston

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  1. Topics Article
  2. Endogenous Growth, Habit Formation and Convergence Speed
  3. Implementing Optimal Monetary Policy in New-Keynesian Models with Inertia
  4. Capital Markets Integration and Labor Market Institutions
  5. The Role of the Real Interest Rate in U.S. Macroeconomic History
  6. Price Dynamics and Asymmetric Business Cycles under Mixed State and Time Dependent Pricing Rules
  7. The Link between the Economic Structure and Financial Development
  8. The Optimum Quantity of Money Revisited: Distortionary Taxation in a Search Model of Money
  9. Sufficient Conditions for Finite Objective Functions in DSGE Models with Deterministic and Stochastic Trends
  10. A Neoclassical Analysis of the Asian Crisis: Business Cycle Accounting for a Small Open Economy
  11. Aging, Retirement, and Savings: A General Equilibrium Analysis
  12. Non-Price Competition, Real Rigidities and Inflation Dynamics
  13. Stock Market Uncertainty and Monetary Policy Reaction Functions of the Federal Reserve Bank
  14. Inflation and Innovation-Driven Growth
  15. Financial Market Shocks during the Great Depression
  16. Inventories and Interest Rates: A Stage of Fabrication Approach
  17. Policy Irreversibility and Interest Rate Smoothing
  18. The Effect of Loss Experiences in a Banking Crisis on Future Expectations and Behavior
  19. The Importance of Commitment in the New Keynesian Model
  20. Relative-Preference Shifts and the Business Cycle
  21. Contributions Article
  22. A Model of the Exchange Rate with Informational Frictions
  23. Communication, Innovation, and Growth
  24. On-the-Job Search and Labor Market Equilibrium
  25. Investment-Specific Shocks and Cyclical Fluctuations in a Frictional Labor Market
  26. An Evaluation of Inflation Forecasts from Surveys Using Real-Time Data
  27. Public Sector Pension Policies and Capital Accumulation in an Emerging Economy: The Case of Brazil
  28. Employment Flows with Endogenous Financing Constraints
  29. Private Equity Returns in a Model of Entrepreneurial Choice with Learning
  30. Nominal Rigidities, News-Driven Business Cycles, and Monetary Policy
  31. How Much Can Engel's Law and Baumol's Disease Explain the Rise of Service Employment in the United States?
  32. Are DSGE Approximating Models Invariant to Shifts in Policy?
  33. Variable Search Intensity with Coordination Unemployment
  34. Households Forming Inflation Expectations: Active and Passive Absorption Rates
  35. Earnings Inequality and the Equity Premium
  36. Advances Article
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  40. On Population Structure and Marriage Dynamics
https://doi.org/10.2202/1935-1690.2106
Keywords for this article
gradualism; interest rate smoothing; irreversibility; Taylor rule

Articles in the same Issue

  1. Topics Article
  2. Endogenous Growth, Habit Formation and Convergence Speed
  3. Implementing Optimal Monetary Policy in New-Keynesian Models with Inertia
  4. Capital Markets Integration and Labor Market Institutions
  5. The Role of the Real Interest Rate in U.S. Macroeconomic History
  6. Price Dynamics and Asymmetric Business Cycles under Mixed State and Time Dependent Pricing Rules
  7. The Link between the Economic Structure and Financial Development
  8. The Optimum Quantity of Money Revisited: Distortionary Taxation in a Search Model of Money
  9. Sufficient Conditions for Finite Objective Functions in DSGE Models with Deterministic and Stochastic Trends
  10. A Neoclassical Analysis of the Asian Crisis: Business Cycle Accounting for a Small Open Economy
  11. Aging, Retirement, and Savings: A General Equilibrium Analysis
  12. Non-Price Competition, Real Rigidities and Inflation Dynamics
  13. Stock Market Uncertainty and Monetary Policy Reaction Functions of the Federal Reserve Bank
  14. Inflation and Innovation-Driven Growth
  15. Financial Market Shocks during the Great Depression
  16. Inventories and Interest Rates: A Stage of Fabrication Approach
  17. Policy Irreversibility and Interest Rate Smoothing
  18. The Effect of Loss Experiences in a Banking Crisis on Future Expectations and Behavior
  19. The Importance of Commitment in the New Keynesian Model
  20. Relative-Preference Shifts and the Business Cycle
  21. Contributions Article
  22. A Model of the Exchange Rate with Informational Frictions
  23. Communication, Innovation, and Growth
  24. On-the-Job Search and Labor Market Equilibrium
  25. Investment-Specific Shocks and Cyclical Fluctuations in a Frictional Labor Market
  26. An Evaluation of Inflation Forecasts from Surveys Using Real-Time Data
  27. Public Sector Pension Policies and Capital Accumulation in an Emerging Economy: The Case of Brazil
  28. Employment Flows with Endogenous Financing Constraints
  29. Private Equity Returns in a Model of Entrepreneurial Choice with Learning
  30. Nominal Rigidities, News-Driven Business Cycles, and Monetary Policy
  31. How Much Can Engel's Law and Baumol's Disease Explain the Rise of Service Employment in the United States?
  32. Are DSGE Approximating Models Invariant to Shifts in Policy?
  33. Variable Search Intensity with Coordination Unemployment
  34. Households Forming Inflation Expectations: Active and Passive Absorption Rates
  35. Earnings Inequality and the Equity Premium
  36. Advances Article
  37. Demystifying the Equity Premium
  38. Is a Calvo Price Setting Model Consistent with Individual Price Data?
  39. The Impact of Aggregate and Sectoral Fluctuations on Training Decisions
  40. On Population Structure and Marriage Dynamics
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