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Bad Luck, Bad Policy, and Learning? A Markov-Switching Approach to Understanding Postwar U.S. Macroeconomic Dynamics

34 Pages Posted: 3 Jul 2016 Last revised: 1 Jul 2017

Gabriela Best

California State University, Fullerton - Mihaylo College of Business & Economics

Joonyoung Hur

The Bank of Korea

Date Written: June 30, 2017

Abstract

In this paper we analyze changes in the Federal Reserve behavior and objectives since the 1960s justified by potentially evolving beliefs—through a real-time learning process—about the structure of the economy and shifts in policymakers’ preferences in the late 1970s. In addition, we allow for changes in the volatility of the structural shocks in a medium scale Markov-switching DSGE model. We evaluate the relative contribution of each narrative to the explanation of the Great Inflation and the Great Moderation. We argue that the interplay between central bank learning and a shift in policy makers’ preferences explains movements in the monetary instrument. In addition, the model captures non-policy related high volatility periods clustered around the late 1960s through the 1970s, specifically supply side shocks that behaved as destabilizing forces driving macroeconomic fluctuations. To conclude, we observe that a change in monetary policy objectives, assumptions about policymakers’ learning process, and Markov-switching volatility are key to fit the model to the U.S. post-war data.

Keywords: Great Inflation, Policy Preferences, Policymakers' Beliefs, Constant Gain Learning, Markov-switching DSGE Models

JEL Classification: C11, D83, E31, E50, E52, E58, E32, E44

Suggested Citation

Best, Gabriela and Hur, Joonyoung, Bad Luck, Bad Policy, and Learning? A Markov-Switching Approach to Understanding Postwar U.S. Macroeconomic Dynamics (June 30, 2017). Available at SSRN: https://ssrn.com/abstract=2803020 or http://dx.doi.org/10.2139/ssrn.2803020

Gabriela Best

California State University, Fullerton - Mihaylo College of Business & Economics ( email )

P.O. Box 6848
Fullerton, CA CA 92834-6848
United States

HOME PAGE: http://www.gabrielabest.com/

Joonyoung Hur (Contact Author)

The Bank of Korea ( email )

+82-2-759-5647 (Phone)

HOME PAGE: http://sites.google.com/site/joonyhur/

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