Working Paper: NBER ID: w16707
Authors: Olivier Coibion; Yuriy Gorodnichenko
Abstract: While the degree of policy inertia in central banks' reaction functions is a central ingredient in theoretical and empirical monetary economics, the source of the observed policy inertia in the U.S. is controversial, with tests of competing hypotheses such as interest-smoothing and persistent-shocks theories being inconclusive. This paper employs real time data; nested specifications with flexible time series structures; narratives; interest rate forecasts of the Fed, financial markets, and professional forecasters; and instrumental variables to discriminate competing explanations of policy inertia. The presented evidence strongly favors the interest-smoothing explanation and thus can help resolve a key puzzle in monetary economics.
Keywords: No keywords provided
JEL Codes: E4; E5; E6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| interest smoothing (E43) | policy inertia (D78) |
| historical behavior of the Federal Reserve (E58) | interest smoothing (E43) |
| Federal Reserve's internal forecasts (E47) | interest rates (E43) |
| control for omitted variables (C20) | interest smoothing (E43) |
| nonmonetary policy shocks (E39) | interest rates (E43) |