2004), Taking two steps at a time: On the optimal pattern of policy rates, mimeo

Most central banks change interest rates in steps of 25, 50 or 75 basis points at scheduled dates. This paper presents a model that determines optimally the step size and the frequency of policy decisions. In contrast to the existing literature we argue that the size of interest rate changes is chosen to help focus policy decisions, which we assume are taken by a Monetary Policy Committee. Moreover, we assume that the preparations of policy meetings are costly and that decisions therefore are scheduled such that an interest rate change is ”likely”. The analysis indicates that the step pattern depends on the variability of the unobserved optimal level of interest rates, policymakers ’ difficulties observing it and their preferences. The model expands the literature by predicting occasional policy rate adjustments by two steps at a time