Interest Rate Misalignments and Monetary Policy Effects: Evidence from U.S. States

Zo Andriantomanga, N Kishor and Labesh Kumar

MPRA Paper from University Library of Munich, Germany

Abstract: This paper examines whether a uniform monetary policy can effectively address diverse state-level economic conditions within the United States. Using quarterly data from 1989-2017 for 33 states, we construct state-level optimal interest rates based on a Taylor rule framework that incorporates local inflation and unemployment gaps. We document significant and persistent deviations between these state-implied rates and the actual federal funds rate, with hierarchical clustering analysis revealing systematic regional patterns in monetary policy misalignment. Using a local projection approach, we find that a one percentage point positive deviation shock reduces headline inflation by 0.6 percentage points and increases unemployment rates, with effects most pronounced for non-tradable sectors. Critically, responses to state-specific deviation shocks are substantially larger and more persistent than responses to aggregate deviation shocks, demonstrating that cross-sectional heterogeneity is essential for understanding monetary policy's regional impacts. Our findings remain robust to alternative specifications, including output gaps, interest rate smoothing, and accounting for unconventional monetary policy.

Keywords: Taylor rule; monetary policy; interest rates; regional business cycles (search for similar items in EconPapers)
JEL-codes: E43 E52 R11 (search for similar items in EconPapers)
Date: 2025-05-14
New Economics Papers: this item is included in nep-cba and nep-mon
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