DESCRIBING THE FED’S CONDUCT WITH TAYLOR RULES: IS INTEREST RATE SMOOTHING IMPORTANT?

In this paper, the author employs models in level and first differences to gain some insights into the presence and significance of the degree of partial adjustment as opposed to a serially correlated policy shock in simple Taylor (1993) rules. In performing the exercise, the author considers potentially important, and usually omitted, regressors such as the quadratic output gap and the credit spread. While it cannot be excluded that serially correlated policy shocks may play a role in describing the federal funds rate path, the findings significantly support the importance of the lagged interest rate also in the 'enriched' Taylor-type models.