Monetary Policy and Macroeconomic Stability Revisited

43 Pages Posted: 17 Jul 2019

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 Cleveland

Multiple version iconThere are 2 versions of this paper

Date Written: June 26, 2019

Abstract

A large literature has established that the Fed’s change from a passive to an active policy response to inflation led to U.S. macroeconomic stability after the Great Inflation of the 1970s. This paper revisits the literature’s view by estimating a generalized New Keynesian model using a full-information Bayesian method that allows for equilibrium indeterminacy and adopts a sequential Monte Carlo algorithm. The model empirically outperforms canonical New Keynesian models that confirm the literature’s view. Our estimated model shows an active policy response to inflation even during the Great Inflation. More importantly, a more active policy response to inflation alone does not suffice for explaining the U.S. macroeconomic stability, unless it is accompanied by a change in either trend inflation or policy responses to the output gap and output growth. This extends the literature by emphasizing the importance of the changes in other aspects of monetary policy in addition to its response to inflation.

Keywords: Monetary policy, Great Inflation, Indeterminacy, Trend inflation, Sequential Monte Carlo

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

Suggested Citation

Hirose, Yasuo and Kurozumi, Takushi and Van Zandweghe, Willem, Monetary Policy and Macroeconomic Stability Revisited (June 26, 2019). FRB of Cleveland Working Paper No. 19-14, June 2019, Available at SSRN: https://ssrn.com/abstract=3421047

Yasuo Hirose

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 (Contact Author)

Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

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