Abstract
AbstractThe recognised approach to designing an optimal monetary policy model is based on the central bank’s ability to mitigate losses using a quadratic criterion subject to the linear structure of the economy. This study examines the United States Federal Reserve’s (Fed) monetary policy in different economic environments. It provides an empirical solution to the central bank’s optimisation problem when preferences are asymmetric in both in˛ation and output gaps. The study tested for structural breaks and uncovered potential evidence of nonlinearities in the Fed’s reaction function, which provides more information on policy objective. The empirical evidence suggests that the Fed’s policy rate differs in these periods. This strongly indicates the presence of asymmetry. Further evidence suggests that the predictive power of the estimated model increases when a smoothing process is allowed.
Highlights
The traditional approach to monetary policy is to use fund rates as a tool to manage irregular uctuations in the economy
This study further examines whether the Federal Reserve (Fed) policy preferences exhibit asymmetry, determined by the magnitude of the threshold variable such as current or lag value of interest rate, in ation, output, unemployment
The results show that smoothing interest rate is relevant for policy consistency
Summary
The traditional approach to monetary policy is to use fund rates as a tool to manage irregular uctuations in the economy. This study further examines whether the Fed policy preferences exhibit asymmetry, determined by the magnitude of the threshold variable such as current or lag value of interest rate, in ation, output, unemployment.
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