Dynamic Limited Dependent Variable Modeling and US Monetary Policy

29 Pages Posted: 30 May 2012 Last revised: 14 Jul 2012

Date Written: 2011


I estimate a forward-looking, dynamic, discrete-choice monetary policy reaction function for the US economy, that accounts for the fact that there are substantial restrictions in the period-to-period changes of the Fed's policy instrument. I Â…find a substantial contrast between the periods before and after Paul Volcker's appointment as Fed Chairman in 1979, both in terms of the Fed's response to expected inflation and in terms of its response to the (perceived) output gap: In the pre-Volcker era the Fed's response to inflation was substantially weaker than in the Volcker-Greenspan era; conversely, the Fed seems to have been more responsive to (inaccurate real-time estimates of) the output gap in the pre-Volcker era than later. These results, which carry through a series of extensions and robustness checks, provide support for the "policy mistakes" hypothesis as an explanation of the stark contrast in US macroeconomic performance between the pre-Volcker and the Volcker/Greenspan periods.

Keywords: Monetary policy rules, Taylor rule, Real-time data, Greenbook forecasts, Federal funds rate, Discrete choice models, Data augmentation, Markov Chain Monte Carlo, Gibbs sampling, Time-varying parameter models, Regime-switching models

JEL Classification: E52, E58, C15, C22, C25

Suggested Citation

Monokroussos, George, Dynamic Limited Dependent Variable Modeling and US Monetary Policy (2011). Journal of Money, Credit, and Banking, Vol. 43, Nos. 2-3, 2011. Available at SSRN: https://ssrn.com/abstract=2070901

George Monokroussos (Contact Author)

Joint Research Centre, Italy ( email )

Via E. Fermi 1
I-21020 Ispra (VA)

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