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Optimal Interest-Rate Smoothing

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  • Michael Woodford

Abstract

This paper considers the desirability of the observed tendency of central banks to adjust interest rates only gradually in response to changes in economic conditions. It shows, in the context of a simple model of optimizing private-sector behaviour, that assignment of an interest-rate smoothing objective to the central bank may be desirable, even when reduction of the magnitude of interest-rate changes is not a social objective in itself. This is because a response of policy to "irrelevant" lagged variables may be desirable owing to the way it steers private-sector expectations of future policy. Copyright 2003, Wiley-Blackwell.

Suggested Citation

  • Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 70(4), pages 861-886.
    • Handle: RePEc:oup:restud:v:70:y:2003:i:4:p:861-886
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    File URL: http://hdl.handle.net/10.1111/1467-937X.00270
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    References listed on IDEAS

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    1. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126, National Bureau of Economic Research, Inc.
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    4. Lars E. O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters, in: The Inflation-Targeting Debate, National Bureau of Economic Research, Inc.
    5. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
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