Working Paper Series No 222
- SverigeS rikSbank, Hans Dillén
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 frequency of policy decisions. In contrast to the existing literature we argue that the size of interest rate changes is chosen to facilitate policy decisions, which we assume are taken by a Monetary Policy Committee. Moreover, we argue that the preparations of policy meetings are costly and that the frequency of meetings is determined such that an interest rate change is ”likely”. The analysis indicates that the step pattern depends on the variability of the optimal level of interest rates, policymakers’ difficulties observing it and their preferences. The model expands the literature by predicting that interest rates are occasionally adjusted by two steps.