Monetary Policy, Inflation and Unemployment in Defense of the Federal Reserve

Centre for Applied Macroeconomics Analysis Working Paper No. 37/2010

56 Pages Posted: 24 Dec 2010

See all articles by Nicolas Groshenny

Nicolas Groshenny

Reserve Bank of New Zealand; Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA)

Date Written: December 24, 2010

Abstract

To what extent did deviations from the Taylor rule between 2002 and 2006 help to promote price stability and maximum sustainable employment? To address that question, this paper estimates a New Keynesian model with unemployment and performs a counterfactual experiment where monetary policy strictly follows a Taylor rule over the period 2002:Q1 - 2006:Q4. The paper finds that such a policy would have generated a sizable increase in unemployment and resulted in an undesirably low rate of inflation. Around mid-2004, when the counterfactual deviates the most from the actual series, the model indicates that the probability of an unemployment rate greater than 8 percent would have been as high as 80 percent, while the probability of an inflation rate above 1 percent would have been close to zero.

Keywords: DSGE Models, Inflation, Unemployment, Taylor Rules

JEL Classification: E32, C51, C52

Suggested Citation

Groshenny, Nicolas, Monetary Policy, Inflation and Unemployment in Defense of the Federal Reserve (December 24, 2010). Centre for Applied Macroeconomics Analysis Working Paper No. 37/2010, Available at SSRN: https://ssrn.com/abstract=1730358 or http://dx.doi.org/10.2139/ssrn.1730358

Nicolas Groshenny (Contact Author)

Reserve Bank of New Zealand ( email )

6011

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA)

ANU College of Business and Economics
Canberra, Australian Capital Territory 0200
Australia

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