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Monetary Policy, Trend Inflation, and the Great Moderation: An Alternative Interpretation

58 Pages Posted: 10 Nov 2009  

Yuriy Gorodnichenko

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Olivier Coibion

University of Texas at Austin

Multiple version iconThere are 2 versions of this paper

Date Written: September 14, 2009

Abstract

With positive trend inflation, the Taylor principle is not enough to guarantee a determinate equilibrium. We provide new theoretical results on restoring determinacy in New Keynesian models with positive trend inflation and combine these with new empirical findings on the Federal Reserve’s reaction function before and after the Volcker disinflation to find that 1) while the Fed likely satisfied the Taylor principle in the pre-Volcker era, the US economy was still subject to self-fulfilling fluctuations in the 1970s, 2) the US economy moved from indeterminacy to determinacy during the Volcker disinflation, and 3) the switch from indeterminacy to determinacy was due to the changes in the Fed’s response to macroeconomic variables and the decline in trend inflation during the Volcker disinflation.

Keywords: Trend inflation, Determinacy, Great Moderation, Monetary Policy

JEL Classification: C22, E3, E43, E5

Suggested Citation

Gorodnichenko, Yuriy and Coibion, Olivier, Monetary Policy, Trend Inflation, and the Great Moderation: An Alternative Interpretation (September 14, 2009). Available at SSRN: https://ssrn.com/abstract=1502910 or http://dx.doi.org/10.2139/ssrn.1502910

Yuriy Gorodnichenko

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States

HOME PAGE: http://www.econ.berkeley.edu/~ygorodni/index.htm

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Olivier Coibion (Contact Author)

University of Texas at Austin ( email )

Austin, TX 78712
United States

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