How optimal is US monetary policy?

Abstract

Most of the literature estimating DSGE models for monetary policy analysis assume that policy follows a simple rule. In this paper we allow policy to be described by various forms of optimal policy -commitment, discretion and quasi-commitment. We find that, even after allowing for Markov switching in shock variances, the inflation target and/or rule parameters, the data preferred description of policy is that the US Fed operates under discretion with a marked increase in conservatism after the 1970s. Parameter estimates are similar to those obtained under simple rules, except that the degree of habits is significantly lower and the prevalence of cost-push shocks greater. Moreover, we find that the greatest welfare gains from the 'Great Moderation' arose from the reduction in the variances in shocks hitting the economy, rather than increased inflation aversion. However, much of the high inflation of the 1970s could have been avoided had policy makers been able to commit, even without adopting stronger anti-inflation objectives. More recently the Fed appears to have temporarily relaxed policy following the 1987 stock market crash, and has lost, without regaining, its post-Volcker conservatism following the bursting of the dot-com bubble in 2000.

All Fluctuations Are Not Created Equal: The Differential Roles of Transitory versus Persistent Changes in Driving Historical Monetary Policy

“…24 Our base model specification -Equation 2 3) yields interestingly different results. 25 If one re-estimates Equation (2) using a conventional unemployment rate gap, one finds -in keeping with most of the literature -evidence for a response to unemployment rate fluctuations in the VGB period. Evidently, the apparent non-response to unemployment rate fluctuations in the VGB period indicated in Table 1 for Equation (2) arises from the fact that the FOMC does not respond to extremely persistent movements in the unemployment rate, and these comprise a large part of the variance.…”

“…Taking these coefficient estimates at face value also indicates that the FOMC's response to inflation rate fluctuations was notably smaller in the MBM than in the VGB period: on average the FOMC increased the federal funds rate by only 0.63 percent for every 1 percent increase in the inflation rate in the MGM period, whereas, in the VGB period, the estimated response is 1.82 percent. The FOMC's short-run response to a 1 percent increase in the unemployment rate is only economically meaningful during the MBM period, and even then it is of only modest economic significance (−084 percent) 25. But these results are artifactual; during this period, the implicit   target of the FOMC was varying substantially.…”

Optimal Time-Consistent Monetary, Fiscal and Debt Maturity Policy

“…The price adjustment cost parameter, φ = 50, implies, given the equivalence between the linearized NKPCs under Rotemberg and Calvo pricing (see Leith and Liu, 2016), that on average rms re-optimize prices every six months -in line with empirical evidence. Finally, the cost-push shock process is parameterized as ρ = 0.939 and σ = 0.052 in line with estimates in Chen et al (2017) and Smets and Wouters (2003).…”

Reassessing the Impact of the US Fiscal Stimulus: The Role of the Monetary Policy Stance

“…Barro and Broadbent (1997), who allow the output gap weight in the policymaker's loss function to vary freely, estimate a value of 1/3, somewhat higher than the value of 0.25 used by Jensen (2002) or McCallum and Nelson (2000) in their theoretical analysis. More recently, Chen et al (2013) investigate the preferences of the Fed by estimating a DSGE model for various forms of optimal policy, and allow the relative weight of other objectives to follow a two-regime Markov switching process. The relative output weights equal 0.64 under the less conservative and 1.46 under the more conservative regime.…”