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Doves, hawks and pigeons: Behavioral monetary policy and interest rate inertia

Federico Favaretto and Donato Masciandaro ()

Journal of Financial Stability, 2016, vol. 27, issue C, 50-58

Abstract: Behavioral bias – loss aversion – can explain monetary policy inertia in setting interest rates. Economic literature has tended to explain inertia in monetary policymaking in terms of frictions and delays, or has stressed the role of governance rules. We introduce a new driver of inertia, independent from frictions and central bank governance settings. While the degree of conservatism doesn’t necessarily produce monetary inertia, we show that introducing loss aversion in individual behavior influences the stance of monetary policy under three different but convergent perspectives. First of all, a Moderation Effect can emerge, i.e. the number of pigeons increases. At the same time also a Hysteresis Effect can become relevant, whereby both doves and hawks soften their attitudes. Finally a Smoothing Effect tends to stabilize the number of pigeons. Together, the three effects consistently cause higher monetary policy inertia.

Keywords: Monetary policy inertia; Central banking; Behavioral economics (search for similar items in EconPapers)
JEL-codes: E52 E58 E03 (search for similar items in EconPapers)
Date: 2016
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