Description: We document a robust and surprising empirical phenomenon: both the U.S. Federal Reserve and the European Central Bank appear to set interest rates partly in response to regional disparities in unemployment rates. This result is exceedingly robust, even after controlling for a wide variety of factors, including the central bank's information set and a battery of explanatory variables. Furthermore, including measures of inter-regional unemployment dispersion in Taylor rule estimates also helps improve the identification of the central banks' responses to inflation and unemployment rates. We propose a variety of statistical and theoretical possibilities to account for this puzzling empirical result, but find that none is consistent with our findings.
Publication Date: 2007