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

Abstract

This paper estimates a New Keynesian model with trend in ‡ation and contrasts Taylor rules featuring …xed versus time-varying in ‡ation target while allowing for passive monetary policy. The estimation is conducted over the Great In ‡ation and the Great Moderation periods. Time-varying in ‡ation target empirically …ts better and active monetary policy prevails in both periods, thereby ruling out sunspots as an explanation of the Great In ‡ation episode. Counterfactual simulations suggest that the decline in in ‡ation volatility since the mid-1980s is mainly driven by monetary policy, while the reduction in output growth variability is explained by the reduced volatility of technology shocks.

Do We Really Know that US Monetary Policy Was Destabilizing in the 1970s?

“…1 The current paper estimates a similar model while taking into account commodity price ‡uctuations and the trade-o¤ faced by the central bank. Our interpretation that the pre-Volcker period should be characterized by determinacy is in line with Orphanides (2004), Bilbiie and Straub (2013) and Haque (2017). Both Orphanides (2004) and Haque (2017) document strong anti-in ‡ationary stance pursued by the Federal Reserve even in the 1970s.…”

Empirical Evidence on the Dynamics of Investment Under Uncertainty in the U.S.*

“…Several studies offer robust evidence regarding changes in the policy reaction function, seeClarida et al (2000),Lubik and Schorfheide (2004),Davig and Leeper (2007),Haque et al (2018),Haque (2019) among others.18 This evidence is also in line with recent research studying the effects of first-moment macroeconomic shocks in presence of the zero lower bound, see P Liu et al (2019)…”

Revisiting the Macroeconomic Effects of Monetary Policy Shocks*

“…Finally, for the response to inflation in the Taylor rule ζ, we set it at different values starting from ζ ¼ 1:5 (the value used by Taylor, 1993) and gradually increasing the degree of responsiveness to ζ ¼ 4. Haque et al (2021) and Haque (2022) estimate variants of the NK model using Bayesian estimation techniques for the postmid-1980s period and find that the Federal Reserve has been highly aggressive in its response to inflation during this period. For instance, the posterior mean estimates of the degree of response to inflation are 3.09 and 4.04, respectively, in Haque et al (2021) and Haque (2022).…”

“…Haque et al (2021) and Haque (2022) estimate variants of the NK model using Bayesian estimation techniques for the postmid-1980s period and find that the Federal Reserve has been highly aggressive in its response to inflation during this period. For instance, the posterior mean estimates of the degree of response to inflation are 3.09 and 4.04, respectively, in Haque et al (2021) and Haque (2022).…”

“…2 See Clarida et al (2000), Lubik and Schorfheide (2004), Haque et al (2021), Haque (2022) for evidence of better monetary policy in the post-1980s.…”