US Post-War Monetary Policy: What Caused the Great Moderation?

36 Pages Posted: 29 Nov 2010

See all articles by Patrick Minford

Patrick Minford

Cardiff University Business School; Centre for Economic Policy Research (CEPR)

Zhirong Ou

Cardiff University - Cardiff Business School

Date Written: November 2010

Abstract

Using indirect inference based on a VAR we confront US data from 1972 to 2007 with a standard New Keynesian model in which an optimal timeless policy is substituted for a Taylor rule. We find the model explains the data both for the Great Acceleration and the Great Moderation. The implication is that changing variances of shocks caused the reduction of volatility. Smaller Fed policy errors accounted for the fall in inflation volatility. Smaller supply shocks accounted for the fall in output volatility and smaller demand shocks for lower interest rate volatility. The same model with differing Taylor rules of the standard sorts cannot explain the data of either episode. But the model with timeless optimal policy could have generated data in which Taylor rule regressions could have been found, creating an illusion that monetary policy was following such rules.

Keywords: Bootstrap, Great Moderation, Indirect Inference, Monetary Policy, New Keynesian Model, Shocks, VAR, Wald Statistic

JEL Classification: E32, E42, E52, E58

Suggested Citation

Minford, Patrick and Ou, Zhirong, US Post-War Monetary Policy: What Caused the Great Moderation? (November 2010). CEPR Discussion Paper No. DP8101. Available at SSRN: https://ssrn.com/abstract=1714873

Patrick Minford (Contact Author)

Cardiff University Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom
+44 29 2087 5728 (Phone)
+44 29 2087 4419 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Zhirong Ou

Cardiff University - Cardiff Business School

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