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A CASE FOR INTEREST RATE INERTIA IN MONETARY POLICY
Author(s) -
Bask Mikael
Publication year - 2014
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.1470
Subject(s) - economics , interest rate , monetary policy , taylor rule , exchange rate , inertia , rational expectations , fisher hypothesis , monetary economics , outcome (game theory) , central bank , forward guidance , nominal interest rate , inflation targeting , credit channel , macroeconomics , real interest rate , econometrics , microeconomics , physics , classical mechanics
We argue that it is not necessary for the central bank to react to the exchange rate to have a desirable outcome in the economy. Indeed, when the Taylor rule includes contemporaneous data on the variables in the rule, the central bank can disregard from the exchange rate as long as there is enough with interest rate inertia in monetary policy. The reason is that interest rate inertia and a reaction to the current nominal exchange rate change are perfect substitutes in monetary policy. Hence, we give a rationale for the central bank to focus on the interest rate change rather than the interest rate level to have a desirable outcome in the economy, which we define as a determinate rational expectation equilibrium that is stable under least squares learning. Copyright © 2012 John Wiley & Sons, Ltd.