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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Interpreting the significance of lagged interest rate in estimated monetary policy rules
William B. English
William R. Nelson
Brian P. Sack
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.


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William B. English & William R. Nelson & Brian P. Sack, Interpreting the significance of lagged interest rate in estimated monetary policy rules, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2002-24, 2002.
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Keywords: Interest rates ; Monetary policy
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