The Optimal Design of Interest Rate Target Changes

Graeme Guthrie and Julian Wright

No 33485, Working Paper Series from Victoria University of Wellington, School of Economics and Finance

Abstract: Most central banks currently implement monetary policy by targeting a short-term interest rate. This paper asks: “What is the optimal form for such interest rate targeting, given the objectives facing central banks?” We find the optimal rule is for the central bank to change the target rate whenever the deviation between its preferred rate and the current target rate reaches some critical level, and in this case the target rate is changed by a discrete amount in the direction of its preferred rate. Despite the simplicity of this rule, we are able to replicate a number of puzzling features of interest rate targeting observed in practice, as well as explain some dynamic properties of market interest rates.

Keywords: Central banks; Federal funds rate; Interest rate smoothing (search for similar items in EconPapers)
Date: 2002
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Persistent link: https://EconPapers.repec.org/RePEc:vuw:vuwecf:33485

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