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Interest Rate Rules and the Response to the Output Gap

Author

Listed:
  • Juan Paez-Farrell

    (Hull University)

Abstract

Modern monetary policy analysis is built around the concept of an interest rate rule that responds to both inflation and output. This paper evaluates the quantitative implications of having a policy rule target different definitions of the output gap in a New Keynesian model with endogenous capital. One crucial result is that different model specifications result in alternative values for potential output, raising the issue of which output gap to target. The results of this paper suggest that targeting the true output gap can be well approximated by a rule that only reacts to inflation.

Suggested Citation

  • Juan Paez-Farrell, 2005. "Interest Rate Rules and the Response to the Output Gap," Macroeconomics 0503016, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpma:0503016
    Note: Type of Document - pdf; pages: 19
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    File URL: https://econwpa.ub.uni-muenchen.de/econ-wp/mac/papers/0503/0503016.pdf
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    References listed on IDEAS

    as
    1. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 115(1), pages 147-180.
    2. 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.
    3. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
    4. 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.
    5. Yash P. Mehra, 1999. "A forward-looking monetary policy reaction function," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 33-54.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Monetary Policy Rules; Output Gap;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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