Working Paper: NBER ID: w0915
Authors: Carl E. Walsh
Abstract: In October 1979 the Federal Reserve shifted from an interest rate oriented operating procedure to a reserves oriented procedure. It is argued in this paper that part of the very large increase in interest rate volatility which resulted from the policy switch may have been due to shifts in the parameters of the money demand equation, shifts due to the adoption-of a reserve aggregates operating procedure. This result is derived by comparing rational expectations equilibria in a simple theoretical model under alternative policy rules. This allows the variance of interest rates to be explicitly expressed as a function of the policy rule.
Keywords: Interest Rates; Monetary Policy; Volatility
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Shift from interest rate-oriented operating procedure to a reserves-oriented procedure (E52) | Increase in the short-run volatility of market interest rates (E43) |
| Reserves-oriented procedure (E52) | Shifts in the parameters of the money demand equation (E41) |
| Shifts in the parameters of the money demand equation (E41) | Increase in the short-run volatility of market interest rates (E43) |
| Policy shift (E65) | Variance of interest rates (E43) |