Does the fed act gradually? A VAR analysis

The tendency for changes in the federal funds rate to be implemented gradually has been considered evidence of an interest-rate smoothing objective for the Federal Reserve. This paper investigates whether gradual funds rate movements can be explained by the dynamic structure of the economy and the uncertainty surrounding that structure, without recourse to including an ad hoc interest-rate smoothing argument in the Fed's objective function. In the absence of parameter uncertainty, the optimal policy involves more aggressive movements in the funds rate than observed. Parameter uncertainty, however, limits the responsiveness of the interest rate. As a result, the optimal policy under parameter uncertainty can account for a considerable portion of the gradualism observed. (C) 2000 Elsevier Science B.V. All rights reserved. JEL classification: E52; E58.