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An overhaul of Federal Reserve doctrine: Nominal income and the Great Moderation

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  • Hendrickson, Joshua R.

Abstract

The Great Moderation is often characterized by the decline in the variability of output and inflation from earlier periods. While a multitude of explanations for the Great Moderation exist, notable research has focused on the role of monetary policy. Specifically, early evidence suggested that this increased stability is the result of monetary policy that responded much more strongly to realized inflation. Recent evidence casts doubt on this change in monetary policy. An alternative hypothesis is that the change in monetary policy was the result of a change in doctrine; specifically the rejection of the view that inflation was largely a cost-push phenomenon. As a result, this alternative hypothesis suggests that the change in monetary policy beginning in 1979 is reflected in the Federal Reserve’s response to expectations of nominal income growth rather than realized inflation as previously argued. I provide evidence for this hypothesis by estimating the parameters of a monetary policy rule in which policy adjusts to forecasts of nominal GDP for the pre- and post-Volcker eras. Finally, I embed the rule in two dynamic stochastic general equilibrium models with gradual price adjustment to determine whether the overhaul of doctrine can explain the reduction in the volatility of inflation and the output gap.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 34 (2012)
Issue (Month): 2 ()
Pages: 304-317

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Handle: RePEc:eee:jmacro:v:34:y:2012:i:2:p:304-317

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Web page: http://www.elsevier.com/locate/inca/622617

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Keywords: Monetary policy rules; Real-time data; Greenbook forecasts; Nominal income target; Great Moderation;

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Cited by:
  1. Robert L. Hetzel, 2012. "Does monetarism retain relevance?," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue 2Q, pages 77-110.
  2. Hendrickson, Joshua, 2010. "Redundancy or Mismeasurement? A Reappraisal of Money," MPRA Paper 21477, University Library of Munich, Germany.
  3. repec:fip:fedreq:y:2012:i:2q:p:77-110:n:vol.98no.2 is not listed on IDEAS

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