The lower bound and the causes of monetary policy inertia: evidence from Sweden. Issue 11 (3rd March 2017)

• Record Type: Journal Article
• Authors: Chappell, Henry W.; McGregor, Rob Roy
• Is Part Of: Applied economics. Volume 49:Issue 11(2017)
• Page Start: 1132
• Page End: 1146
• Publication Date: 2017-03-03
• Subjects: Monetary policy -- central banking -- zero lower bound -- dynamic Tobit; E52 -- E58 -- E65; Economics -- Periodicals; 330
• DOI: 10.1080/00036846.2016.1213360
• Languages: English
• ISSNs: 0003-6846

Abstract

ABSTRACT: In 2009, in the midst of a global recession, Sweden's Riksbank approached a lower bound on nominal interest rates. This encounter with the lower bound provides a natural experiment for investigating the causes of monetary policy inertia. To exploit this experiment, we estimate Taylor rules with Tobit specifications that permit both interest rate smoothing and persistent shocks (serial correlation) as explanations for inertia. The interest rate smoothing hypothesis leads to a specification in which lagged actual values of the dependent variable appear on the right-hand side of the Taylor rule, while the persistent shocks hypothesis leads to a specification in which lagged values of an unobserved latent dependent variable appear on the right-hand side of the Taylor rule. The divergence of actual and latent dependent variables that occurs at the lower bound provides leverage in distinguishing the two hypotheses. For a conventional Taylor rule, we find evidence of both sources of inertia. For a modified Taylor rule that includes a measure of financial stress, our evidence suggests that interest rate smoothing is the principal source of monetary policy inertia.