DP7341 Monetary Policy Inertia: More a Fiction than a fact?

Author(s): Agostino Consolo , Carlo A Favero

Publication Date: June 2009

Keyword(s): Monetary Policy Rulkes , Weak Identification

JEL(s): E52 , E58 , G12

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP7341.asp.asp

Empirical estimates of monetary policy reaction functions feature a very high estimated degree of monetary policy inertia. This evidence is very hard to reconcile with the alternative evidence of low predictability of monetary policy rates. In this paper we examine the potential relevance of the problem of weak instruments to correctly identify the degree of monetary policy inertia in forward looking monetary policy reaction function of the type originally proposed by Taylor (1993). After appropriately diagnosing and taking care of the weak instruments problem, we find an estimated degree of policy inertia which is significantly lower than the common value in the empirical literature on monetary policy rules.