Canonical dynamics mechanism of monetary policy and interest rate

Abstract

Interest rates are the fundamental elements of financial and economic activities, and their movements are the major risk factors driving the global capital flows. In the United States, the central bank (Federal Reserve Bank) uses the Fed Funds Rate (FFR, the overnight borrowing rate between banks) as the key tool to anchor its monetary policy for maintaining both sustainable growth and price stability. It has been a sophisticated art and science for the Federal Open Market Committee (FOMC, the primary unit of the FRB for setting the FFR) to balance growth and inflation by tuning the FFR. Among a few models trying to quantitatively assess the FOMC's efforts on FFR determination is the popular Taylor Rule (Taylor (1993)) for best outlining the thoughts of arguments from the beginning. This paper is based on the R&D works from the Seminar On Adaptive Regression (SOAR) jointly sponsored by G5 Capital Management, LLC. and SIFEON, Ltd., which is founded by Dr. Jeng (Ph.D. of Statistics, UC Berkeley). We would like to thank all the members who contributed to numerous discussions and simulations in SOAR. © 2008 Springer-Verlag Berlin Heidelberg.