Working Papers - details - WEF0032
WEF0032
Inertia in Taylor Rules
John Driffill, Zeno Rotondi
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Abstract
The inertia found in econometric estimates of interest rate
rules is a continuing puzzle. Many reasons for it have been offered,
though unsatisfactorily, and the issue remains open. In the
empirical literature on interest rate rules, inertia in setting interest
rates is typically modeled by specifying a Taylor rule with the
lagged policy rate on the right hand side. We argue that inertia
in the policy rule may simply reflect the inertia in the economy
itself, since optimal rules typically inherit the inertia present in
the model of the economy. Our hypothesis receives some support
from US data. Hence we agree with Rudebusch (2002) that
monetary inertia is, at least partly, an illusion, but for different
reasons.