Interest Rate Misalignments and Monetary Policy Effects: Evidence from U.S. States

Andriantomanga, Zo and Kishor, N. Kundan and Kumar, Labesh (2025): Interest Rate Misalignments and Monetary Policy Effects: Evidence from U.S. States.

Abstract

This paper examines whether a uniform monetary policy can effectively address diverse state-level economic conditions within the United States. Using quarterly data from 1989-2017 for 33 states, we construct state-level optimal interest rates based on a Taylor rule framework that incorporates local inflation and unemployment gaps. We document significant and persistent deviations between these state-implied rates and the actual federal funds rate, with hierarchical clustering analysis revealing systematic regional patterns in monetary policy misalignment. Using a local projection approach, we find that a one percentage point positive deviation shock reduces headline inflation by 0.6 percentage points and increases unemployment rates, with effects most pronounced for non-tradable sectors. Critically, responses to state-specific deviation shocks are substantially larger and more persistent than responses to aggregate deviation shocks, demonstrating that cross-sectional heterogeneity is essential for understanding monetary policy's regional impacts. Our findings remain robust to alternative specifications, including output gaps, interest rate smoothing, and accounting for unconventional monetary policy.

• Item Type: MPRA Paper
• Language: English
• Keywords: Taylor rule, monetary policy, interest rates, regional business cycles
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; R - Urban, Rural, Regional, Real Estate, and Transportation Economics > R1 - General Regional Economics > R11 - Regional Economic Activity: Growth, Development, Environmental Issues, and Changes

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