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Byline: Agostino Consolo, Carlo A. Favero
Empirical estimates of monetary policy reaction functions feature a
very high estimated degree of monetary policy inertia. This evidence is
very hard of 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. Discretion versus policy rules in practice.
Canergie-Rochester Conference Series on Public Policy, 39, 195-214].
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.
IGIER-Bocconi University, IGIER, Department of Finance Bocconi
University, and CEPR, Italy
Received 14 March 2008; Revised 18 June 2009; Accepted 23 June 2009