The start of interest rate smoothing in the US: Is it a monetary or fiscal story?

This article revisits the key issue raised by researchers who have empirically investigated the behaviour of short term US interest rates during the period 1890-1933. The seminal article of Mankiw, Miron and Weil (1987) argues that changes in the behaviour of nominal interest rates is best explained as a monetary regime shift that occurred with the founding of the Federal reserve in 1914. This explanation is rejected by Newbold, Lehybourne, Sollis and Wohar (2001) who show that fiscal and regulatory changes (driven by the needs of World War1 financing) best explain the changing behaviour of interest rates that they identify as beginning in mid-1917. We find, using three different statistical procedures that a structural break in the second moment of interest rates occurred in early 1915. This supports the monetary regime shift argument of MMW by illustrating that the interest rate smoothing policies of the FED can be observed as a variance break in short term interest rates.