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Did the Great Inflation occur despite policymaker commitment to a Taylor rule?

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  • James Bullard
  • Stefano Eusepi

Abstract

The authors study the hypothesis that misperceptions of trend productivity growth during the onset of the productivity slowdown in the United States caused much of the great inflation of the 1970s. They use the general equilibrium, sticky price framework of Woodford (2002), augmented with learning using the techniques of Evans and Honkapohja (2001). The authors allow for endogenous investment as well as explicit, exogenous growth in productivity and the labor input. They assume the monetary policymaker is committed to using a Taylor-type policy rule. The authors study how this economy reacts to an unexpected change in the trend productivity growth rate under learning. They find that a substantial portion of the observed increase in inflation during the 1970s can be attributed to this source.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2003-20.

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Date of creation: 2003
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Handle: RePEc:fip:fedawp:2003-20

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Keywords: Equilibrium (Economics) ; Monetary policy ; Macroeconomics ; Inflation (Finance) ; Productivity;

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  1. Argia M. Sbordone, 2001. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Departmental Working Papers 199822, Rutgers University, Department of Economics.
  2. George W. Evans & Seppo Honkapohja, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," University of Oregon Economics Department Working Papers 2001-6, University of Oregon Economics Department, revised 03 Aug 2001.
  3. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
  4. Orphanides, Athanasios, 2001. "Monetary policy rules, macroeconomic stability and inflation: a view from the trenches," Working Paper Series 0115, European Central Bank.
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  21. Cho, In-Koo & Williams, Noah & Sargent, Thomas J, 2002. "Escaping Nash Inflation," Review of Economic Studies, Wiley Blackwell, vol. 69(1), pages 1-40, January.
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  26. Orphanides, Athanasios, 2000. "The quest for prosperity without inflation," Working Paper Series 0015, European Central Bank.
  27. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, July.
  28. Bruce E. Hansen, 2001. "The New Econometrics of Structural Change: Dating Breaks in U.S. Labour Productivity," Journal of Economic Perspectives, American Economic Association, vol. 15(4), pages 117-128, Fall.
  29. Athanasios Orphanides, 2002. "Monetary policy rules and the Great Inflation," Finance and Economics Discussion Series 2002-8, Board of Governors of the Federal Reserve System (U.S.).
  30. Bai, Jushan & Lumsdaine, Robin L & Stock, James H, 1998. "Testing for and Dating Common Breaks in Multivariate Time Series," Review of Economic Studies, Wiley Blackwell, vol. 65(3), pages 395-432, July.
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  33. Preston, Bruce, 2008. "Adaptive learning and the use of forecasts in monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3661-3681, November.
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