We assess whether recent empirical evidence that Federal Reserve learning caused the Great Inflation is consistent with forecasts published in the Greenbook. If the rise and fall in inflation really was caused by the Federal Reserve learning the Phillips curve then that should be fully reflected in Greenbook forecasts. It is not. The difficulty is that empirical evidence is predicated on the Federal Reserve making forecasts that are much more volatile than those in the Greenbooks. If consistency with Greenbook forecasts is required then evidence that Federal Reserve learning caused the Great Inflation is much weaker. Our results suggest a larger role for other causes than previously thought. * We greatly appreciate Tao Zha making available his C++ routines for Bayesian MCMC estimation. We also thank Knut Anton Mork, Antti Ripatti, and seminar participants at Bank of England, Birkbeck, Cardiff, Durham, Glasgow, Humboldt, Oslo (2nd Workshop on Monetary Policy), Queen's Belfast, Warwick and York for helpful comments and suggestions. Martin Ellison acknowledges support from an ESRC Research Fellowship, "Improving Monetary Policy for the 21st Century" (RES-000-27-0126). The views expressed in this paper do not necessarily reflect those of the ECB.
This paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB.
The 20th anniversary of Economic and Monetary Union (EMU) offers an opportunity to look back on the record of the European Central Bank (ECB) and learn lessons that can improve the conduct of policy in the future. This volume charts the way the ECB has defined, interpreted, and applied its monetary policy framework—its strategy—over the years from its inception, in search of evidence and lessons that can inform those reflections. Our ‘Tale of Two Decades’ is largely a tale of ‘two regimes’: one—stretching slightly beyond the ECB’s mid-point—marked by decent growth in real incomes and a distribution of shocks to inflation almost universally to the upside; and the second—starting well into the post-Lehman period—characterized by endemic instability and crisis, with the distribution of shocks eventually switching from inflationary to continuously disinflationary. We show how the most defining feature of the ECB’s monetary policy framework, its characteristic definition of price stability with a hard 2 per cent ceiling, functioned as a key shock absorber in the relatively high-inflation years prior to the crisis, but offered a softer defence in the face of the disinflationary forces that hit the euro area in its aftermath. The imperative to halt persistent disinflation in the post-crisis era therefore called for a radical, unprecedented policy response, comprising negative policy rates, enhanced forms of forward guidance, a large asset purchase programme and targeted long-term loans to banks. We study the multidimensional interactions among these four instruments and quantify their impact on inflation and the macroeconomy.
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