Please cite this article in press as: Moreira, R. R., & Monte, E.Z. Reviewing monetary policy inertia and its effects: The fractional integration approach for an emerging economy. The Quarterly Review of Economics and Finance (2020), https://doi.org/10.1016/j.qref.2020.05.006 ARTICLE IN PRESS G Model QUAECO-1364; No. of Pages 8 The Quarterly Review of Economics and Finance xxx (2020) xxx–xxx Contents lists available at ScienceDirect The Quarterly Review of Economics and Finance journa l h om epage: www.elsevier.com/locate/qref Reviewing monetary policy inertia and its effects: The fractional integration approach for an emerging economy Ricardo Ramalhete Moreira ∗ , Edson Zambon Monte Federal University of Espírito Santo, Brazil a r t i c l e i n f o Article history: Received 12 August 2019 Received in revised form 13 February 2020 Accepted 17 May 2020 Available online xxx JEL classification: C14 E52 E58 Keywords: Monetary policy inertia Taylor rule Fractional integration Brazil a b s t r a c t This paper addressed the monetary policy inertia of a relevant emerging economy based on the frac- tional integration approach (Geweke and Porter-Hudak, 1983; Baillie et al. 1996), so that we avoided the potential spurious estimates for such an inertia that can be caused by adopting conventional unit root tests, which were usually applied to the related literature. We thus confirmed the hypothesis of a high monetary policy inertia (Clarida et al., 1999), even after controlling for long memory in time series. Furthermore, we identified a positive relationship between inflationary expectations and the inertial component. It means that, under an inflation targeting regime, central banks should adjust both the basic interest rate and its inertial path in order to accomplish the inflation target over time. © 2020 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved. 1. Introduction Taylor (1993) suggested that fluctuations in the observed con- ditions, such as in the inflation rate and/or in the level of economic activity, stimulate changes at the level of the operational goals of central banks, particularly concerning the short-term interest rate – Sack and Wieland (1999) and Woodford (2003). In turn, it is widely accepted that the explanatory power of an estimation for basic interest rates increases when the policy inertia is considered. Thus, the coefficient of monetary policy inertia, associated with the lagged interest rate, indicates that central banks adjust the pol- icy instrument slowly and sparingly in response to macroeconomic fluctuations. Regarding the international empirical literature, some estimates showed a statistically significant coefficient of inertia between 0.7 and 0.8, which was considered a high level (Clarida, Galí, & Gertler, 1999). Several studies argued that the high gradualism of the pol- icy is a deliberate consequence of central banks‘strategy in order to avoid volatility in interest rates and its impacts on the finan- ∗ Corresponding author at: Av. Fernando Ferrari, 514, Goiabeiras, Vitória, ES, CEP 29075-910, Brazil. E-mail addresses: ricardo.moreira@ufes.br (R.R. Moreira), edson.monte@ufes.br (E.Z. Monte). cial market, to deal with uncertainties regarding the future effects of changes in interest rates and to serve as an adequate mech- anism to manage expectations – Sack and Wieland (1999) and Bernanke (2004). In contrast, studies such as those by Rudebusch and Svensson (1999) and Rudebusch (2006) argued that the iner- tial movement found in the literature represents a very slow, late behaviour of the authorities in response to macroeconomic evo- lution and that less timid movements would be more effective in stabilising both output and inflation. The first main goal of our study was to test for the hypothesis of a particular statistical problem in estimates regarding monetary pol- icy inertia: the existence of long-memory or long-range dependence in data and its consequence in terms of an overestimation of such results. The statistical error of disregarding long-memory is that, for instance, when a time series is assumed as stationary by the con- ventional unit root tests, but it actually presents long-memory, the resulting auto-regressive inference commonly overestimates coef- ficients. Thus, one way to deal appropriately with long-memory in the data is by the fractional integration approach (Baillie, Chung, & Tieslau, 1996; Geweke & Porter-Hudak, 1983; Reisen, Abraham, & Lopes, 2001; Reisen, Cribari-Neto, & Jensen, 2003; Wei, 2006). Our initial contribution to the associated literature was to estimate monetary policy inertia in Brazil, but only after controlling for long memory. The particular case of Brazil is an important one as some authors have previously identified expressive values of its mone- https://doi.org/10.1016/j.qref.2020.05.006 1062-9769/© 2020 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved.