Monetary Magic? How the Fed Improved the Flexibility of the U.S. Economy

30 Pages Posted: 15 Feb 2006

See all articles by Tamim Bayoumi

Tamim Bayoumi

International Monetary Fund (IMF); Centre for Economic Policy Research (CEPR)

Silvia Sgherri

International Monetary Fund (IMF)

Date Written: February 2004

Abstract

Extending recent theoretical contributions on sources of inflation inertia, we argue that monetary uncertainty accounts for sluggish expectations adjustment to nominal disturbances. Estimating a model in which rational individuals learn over time about shifts in U.S. monetary policy and the Phillips curve, we find strong evidence that this link exists. These results bring into question the standard approach for evaluating monetary rules by assuming unchanged private sector responses, help clarify the role of monetary stability in reducing output variability in the United States and elsewhere, and tell a subtle and dynamic story of the interaction between monetary policy and the supply side of the economy.

Keywords: Inflation dynamics, Monetary policy, Kalman filter

JEL Classification: E31, E52, C51

Suggested Citation

Bayoumi, Tamim and Sgherri, Silvia, Monetary Magic? How the Fed Improved the Flexibility of the U.S. Economy (February 2004). IMF Working Paper, Vol. , pp. 1-30, 2004. Available at SSRN: https://ssrn.com/abstract=878847

Tamim Bayoumi (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-6333 (Phone)
202-623-4795 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Silvia Sgherri

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

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