Monetary Policy, Self-Fulfilling Expectations and the U.S. Business Cycle

63 Pages Posted: 18 May 2020

See all articles by Giovanni Nicolò

Giovanni Nicolò

Board of Governors of the Federal Reserve System

Date Written: May 5, 2020

Abstract

I estimate a medium-scale New-Keynesian model and relax the conventional assumption that the central bank adopted an active monetary policy by pursuing inflation and output stability over the entire post-war period. Even after accounting for a rich structure, I find that monetary policy was passive prior to the Volcker disinflation. Sunspot shocks did not represent quantitatively relevant sources of volatility. By contrast, such passive interest rate policy accommodated fundamental productivity and cost shocks that de-anchored inflation expectations, propagated via self-fulfilling inflation expectations and constituted the primary sources of the run-up in inflation from the 1960s through the late 1970s.

Keywords: Monetary policy; Business cycle; Expectations; Indeterminacy; Bayesian methods

JEL Classification: C11; C52; C54; E31; E32; E52

Suggested Citation

Nicolò, Giovanni, Monetary Policy, Self-Fulfilling Expectations and the U.S. Business Cycle (May 5, 2020). FEDS Working Paper No. 2020-035 https://doi.org/10.17016/FEDS.2020.035 , Available at SSRN: https://ssrn.com/abstract=3601309

Giovanni Nicolò (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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