Do we really know that U.S. monetary policy was destabilizing in the 1970s?

Abstract

The paper re-examines whether the Federal Reserve's monetary policy was a source of instability during the Great In ‡ation by estimating a sticky-price model with positive trend in ‡ation, commodity price shocks and sluggish real wages. Our estimation provides empirical evidence for substantial wage-rigidity and …nds that the Federal Reserve responded aggressively to in ‡ation but negligibly to the output gap. In the presence of non-trivial real imperfections and well-identi…ed commodity price-shocks, U.S. data prefers a determinate version of the New Keynesian model: monetary policy-induced indeterminacy and sunspots were not causes of macroeconomic instability during the pre-Volcker era.

Monetary Policy, Inflation Target and the Great Moderation: An Empirical Investigation

“…This paper is the …rst one to test for indeterminacy using a full-information structural approach while allowing for both positive trend in ‡ation and time variation in the Federal Reserve's in ‡ation target. The …nding that the pre-Volcker period could possibly be characterized by a unique equilibrium is in line with Orphanides (2004), Bilbiie and Straub (2013) and Haque, Groshenny and Weder (2018). Orphanides (2004) …nds an active response to expected in ‡ation in a Taylor-type rule estimated for the pre-1979 period, thereby claiming that self-ful…lling in ‡ation expectations cannot be a source of macroeconomic instability during the Great In ‡ation.…”

“…Accordingly, they document passive monetary policy during the pre-Volcker period being consistent with equilibrium determinacy. Haque, Groshenny and Weder (2018) document that commodity price shocks during the seventies generated a trade-o¤ for the Federal Reserve in stabilizing in ‡ation and the output gap.…”

Monetary Policy, Self-Fulfilling Expectations and the U.S. Business Cycle

“…In line with the work of Kiley (2007), Ascari and Ropele (2009), Coibon and Gorodnichenko (2011), Hirose et al (2017), andHaque et al (2019) among others, studies on the conduct of monetary policy would need to account for the positive trend inflation observed in the U.S. macroeconomic history. While the findings of these papers are based on parsimonious models, Arias et al (2019) transparently describe the difficulties of including such analysis in the context of a medium-scale model, and possible extensions of the current work could help overcome such obstacles.…”

A Bayesian evaluation of an efficiency-wage model with indeterminacy

“…when the model is determinate or is outside the unit circle under indeterminacy. Under determinacy the Blanchard-Kahn condition is satis…ed and the absolute value of ' is inside the unit circle since the number of explosive roots of the original linear rational expectations model in (25) already equals the number of expectational variables in the model. Then the autoregressive process !…”

“…That is the goal of the present paper. Given the mostly theoretic interest that models with indeterminacy have received over the last two decades, using state of the art Bayesian estimation techniques will add a further dimension to the discussion of these models and our empirical evaluation will help economists assess the indeterminacy framework of business cycle research (see also Lubik, 2016 andHaque et al, 2019). Speci…cally, the theoretical model is estimated in both determinacy and indeterminacy regions by full information Bayesian methods using quarterly U.S. data covering the period from 1964:I to 2007:IV.…”