Monetary Policy, Self-Fulfilling Expectations and the U.S. Business Cycle
63 Pages Posted: 18 May 2020
Date Written: May 5, 2020
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: Suggested Citation