Why does the Monetary Policy Committee smooth interest rates?

David Cobham

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Monetary Policy and Economic Impact Global Financial Crisis and Policies Economic theories and models

Abstract

Explanations of why the monetary authorities in different countries seem to smooth interest rates have focused on the official dislike of financial market volatility, aspects of the decision‐making process, responses to uncertainty, inertial behaviour in a forward‐looking environment, and serial correlation of shocks to the policymakers' expectations. This paper first shows that policy has been smoothest and comparable to that in other countries in the period of inflation targeting with Bank of England control of interest rates since 1997. It then uses the remarkably detailed evidence available from the minutes of the Monetary Policy Committee to evaluate the relevance of the various explanations of smoothing for the UK in this period. The paper concludes that the explanation of interest rate smoothing should be sought primarily in the serial correlation of shocks, together with some minor and short‐term influences from uncertainty, while the other explanations turn out to be not relevant.

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References

2000Open-Economy Inflation Targeting 1999Optimal Monetary Policy Inertia 2002Term structure evidence on interest rate smoothing and monetary policy inertia 1991Interest rates and the conduct of monetary policy 2001Is the Fed Too Timid? Monetary Policy in an Uncertain World 2000Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence 1995Federal Reserve interest rate targeting, rational expectations, and the term structure 1999The Taylor Rule: A Useful Monetary Policy Benchmark for the Euro Area?

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