Interpreting the significance of lagged interest rate in estimated monetary policy rules

William B. English, William R. Nelson and Brian P. Sack

No 2002-24, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

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.

Keywords: Interest rates; Monetary policy (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin and nep-mon
Date: Written 2002
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