Overnight monetary policy in the United States: Active or interest-rate smoothing?

This paper deals with active monetary policy and interest-rate smoothing regimes. In active monetary policy, changes in short-term interest rates are due to the exogenous actions of the central bank. Such a policy is successful only when economic agents in the money market are policy invariant in the sense that their behaviors are constant under interventions. Otherwise, an interest-rate-smoothing regime in which the central bank follows a “rule-based” policy is optimal. It was found that the coefficient of Fed funds rate in Treasury bill-Fed funds rates relationship is not policy invariant while the coefficient of the Treasury bill rate in Fed funds-Treasury bills rates relationship is policy invariant. Consequently, the optimal overnight monetary policy would be an interest-rate-smoothing process. It was found that such a policy has been followed in the United States.