Monetary Policy and Macroeconomic Stability Revisited

30 Pages Posted: 9 Jan 2017

See all articles by Yasuo Hirose

Yasuo Hirose

Faculty of Economics, Keio University

Takushi Kurozumi

Bank of Japan

Willem Van Zandweghe

Federal Reserve Bank of Kansas City

Date Written: January 2017

Abstract

A large literature with canonical New Keynesian models has established that the Fed's policy change from a passive to an active response to inflation led to U.S. macro-economic stability after the Great Inflation of the 1970s. We revisit this view by estimating a staggered price model with trend inflation using a Bayesian method that allows for equilibrium indeterminacy and adopts a sequential Monte Carlo algorithm. The model empirically outperforms a canonical New Keynesian model and demonstrates an active response to inflation even in the Great Inflation era, during which the U.S. economy was likely in the indeterminacy region of the model's parameter space. A more active response to inflation alone does not suffice for explaining the shift to determinacy after the Great Inflation, unless it is accompanied by a decline in trend inflation or a change in policy responses to the output gap and output growth.

Keywords: Monetary Policy; Great Inflation; Equilibrium Indeterminacy; Generalized New Keynesian

JEL Classification: C11; C52; C62; E31; E52

Suggested Citation

Hirose, Yasuo and Kurozumi, Takushi and Van Zandweghe, Willem, Monetary Policy and Macroeconomic Stability Revisited (January 2017). Federal Reserve Bank of Kansas City Working Paper No. 17-01. Available at SSRN: https://ssrn.com/abstract=2894551 or http://dx.doi.org/10.2139/ssrn.2894551

Yasuo Hirose (Contact Author)

Faculty of Economics, Keio University ( email )

2-15-45 Mita, Minato-ku
Tokyo, 108-8345
Japan

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

Takushi Kurozumi

Bank of Japan ( email )

2-1-1 Hongoku-cho
Nihonbashi
Chuo-ku Tokyo 103-8660
Japan

Willem Van Zandweghe

Federal Reserve Bank of Kansas City ( email )

1 Memorial Drive
Kansas City, MO 64198
United States

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