The relative importance of term spread, policy inertia and persistent policy shocks in estimated monetary policy rulesa structural aproach

Abstract

This paper estimates a standard version of the New Keynesian Monetary (NKM) model augmented with term structure in order to analyze two types of issue. First we analyze the relative importance of policy inertia, persistent policy shocks and the term spread in the estimated U.S. monetary policy rule. Second, we study the ability of the model to reproduce some stylized facts such as high persistent dynamics and the weak comovement between economic activity and inflation observed in actual U.S. data. The estimation procedure implemented is a classical structural method based on the indirect inference principle. The empirical results show that (i) policy inertia and persistent policy shocks are significant determinants in the estimated U.S. monetary policy rule; (ii) the Fed does not seem to respond independently to the spread; and (iii) the model augmented with term structure reproduces the weak comovement between economic activity and inflation as well as the strong comovement at medium- and long-term forecast horizons between the Fed rate and the 1-year rate observed in U.S. data.