Working Paper

Term structure evidence on interest rate smoothing and monetary policy inertia

Abstract: Numerous studies have used quarterly data to estimate monetary policy rules or reaction functions that appear to exhibit a very slow partial adjustment of the policy interest rate. The conventional wisdom asserts that this gradual adjustment reflects a policy inertia or interest rate smoothing behavior by central banks. However, such quarterly monetary policy inertia would imply a large amount of forecastable variation in interest rates at horizons of more than three months, which is contradicted by evidence from the term structure of interest rates. The illusion of monetary policy inertia evident in the estimated policy rules likely reflects the persistent shocks that central banks face.

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2001

Number: 2001-02