The Conquest of U.S. Inflation: Learning and Robustness to Model Uncertainty

57 Pages Posted: 1 Jun 2005

See all articles by Timothy Cogley

Timothy Cogley

Leonard N. Stern School of Business - Department of Economics

Thomas J. Sargent

New York University (NYU) - Department of Economics, Leonard N. Stern School of Business; National Bureau of Economic Research (NBER)

Date Written: April 2005

Abstract

Previous studies have interpreted the rise and fall of U.S. inflation after World War II in terms of the Fed's changing views about the natural rate hypothesis but have left an important question unanswered. Why was the Fed so slow to implement the low-inflation policy recommended by a natural rate model even after economists had developed statistical evidence strongly in its favor? Our answer features model uncertainty. Each period a central bank sets the systematic part of the inflation rate in light of updated probabilities that it assigns to three competing models of the Phillips curve. Cautious behavior induced by model uncertainty can explain why the central bank presided over the inflation of the 1970s even after the data had convinced it to place much the highest probability on the natural rate model.

Keywords: natural unemployment rate, Phillips curve, Bayes' law, anticipated utility, robustness

JEL Classification: E31, E58, E65

Suggested Citation

Cogley, Timothy and Sargent, Thomas J., The Conquest of U.S. Inflation: Learning and Robustness to Model Uncertainty (April 2005). Available at SSRN: https://ssrn.com/abstract=701291

Timothy Cogley (Contact Author)

Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
530-752-1581 (Phone)
530-752-9382 (Fax)

Thomas J. Sargent

New York University (NYU) - Department of Economics, Leonard N. Stern School of Business ( email )

269 Mercer Street
New York, NY 10003
United States
212-998-3548 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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