Monetary policy and macroeconomic stability revisited

Yasuo Hirose, Takushi Kurozumi, Willem Van Zandweghe

Research output: Contribution to journalArticle

Abstract

A large literature has established the view that the Fed's change from a passive to an active policy response to inflation led to U.S. macroeconomic stability after the Great Inflation of the 1970s. We revisit this view by estimating a generalized New Keynesian model using a full-information Bayesian method that allows for indeterminacy of equilibrium and adopts a sequential Monte Carlo algorithm. The estimated model empirically outperforms canonical New Keynesian models that confirm the literature's view. It also points to substantial uncertainty about whether the policy response to inflation was active or passive during the Great Inflation. More importantly, a more active policy response to inflation alone does not suffice for explaining the U.S. macroeconomic stability, unless it is accompanied by a change in either trend inflation or policy responses to the output gap and output growth. This extends the literature by emphasizing the importance of the changes in other aspects of monetary policy in addition to its response to inflation.

Original languageEnglish
Pages (from-to)255-274
Number of pages20
JournalReview of Economic Dynamics
Volume37
DOIs
Publication statusPublished - 2020 Jul

Keywords

  • Equilibrium indeterminacy
  • Great Inflation
  • Monetary policy
  • Sequential Monte Carlo
  • Trend inflation

ASJC Scopus subject areas

  • Economics and Econometrics

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