A Realistic Model for Official Interest Rates

TitleA Realistic Model for Official Interest Rates
Publication TypeWorking Paper
Year of Publication2008
AuthorsJD. Tena, E. Otranto
Number2008_02
Keywordsimpulse-response functions, monetary policy, monetary shocks
Abstract

This paper extends the VAR methodology to examine the consequences of monetary policy decisions by considering two types of nonlinearities in the determination of official interest rates: 1) the asymmetry related to the different nature of the discrete and infrequent positive and negative interest rate movements determined by central bankers; and 2) the convexity in the transmission of policy shocks induced by the nonnegativity constraint in interest rates. For the UK, we find evidence of both types of asymmetries. Moreover, the operational independence granted to the Bank of England involved drastic changes on the interpretation of the reaction function of the monetary authority and the consequences of monetary shocks. In the US, responses to unexpected interest rate shocks are far more symmetric. Results highlight the importance of considering all types of asymmetries when studying monetary transmission.

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