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Monetary policy rules, macroeconomic stability and inflation: a view from the trenches

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Author Info
Athanasios Orphanides

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Abstract

I estimate a forward-looking monetary policy reaction function for the Federal Reserve for the periods before and after Paul Volcker's appointment as Chairman in 1979, using information that was available to the FOMC in real time from 1966 to 1995. The results suggest broad similarities in policy and point to a forward looking approach to policy consistent with a strong reaction to inflation forecasts during both periods. This contradicts the hypothesis, based on analysis with ex post constructed data, that the instability of the Great Inflation was the result of weak FOMC policy responses to expected inflation. A difference is that prior to Volcker's appointment, policy was too activist in reacting to perceived output gaps that retrospectively proved overambitious. Drawing on contemporaneous accounts of FOMC policy, I discuss the implications of the findings for alternative explanations of the Great Inflation and the improvement in macroeconomic stability since then.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2001-62.

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Date of creation: 2001
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Handle: RePEc:fip:fedgfe:2001-62

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Keywords: Monetary policy Federal Open Market Committee

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  1. Robert L. Hetzel, 2000. "The Taylor rule : is it a useful guide to understanding monetary policy?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 1-33. [Downloadable!]
  2. Lawrence J. Christiano & Christopher Gust, 2000. "The expectations trap hypothesis," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q II, pages 21-39. [Downloadable!]
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  3. Bennett T. McCallum, 2001. "Should Monetary Policy Respond Strongly to Output Gaps?," American Economic Review, American Economic Association, vol. 91(2), pages 258-262, May. [Downloadable!] (restricted)
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  4. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Kevin J. Lansing, 2002. "Learning about a shift in trend output: implications for monetary policy and inflation," Working Papers in Applied Economic Theory 2000-16, Federal Reserve Bank of San Francisco. [Downloadable!]
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  6. Athanasios Orphanides, 2000. "The quest for prosperity without inflation," Working Paper Series 15, European Central Bank. [Downloadable!]
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  7. Bennett T. McCallum & Edward Nelson, 1998. "Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model," NBER Working Papers 6599, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. John C. Williams, 2003. "Simple rules for monetary policy," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12. [Downloadable!]
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  9. Orphanides, Athanasios & Wieland, Volker, 2000. "Inflation zone targeting," European Economic Review, Elsevier, vol. 44(7), pages 1351-1387, June. [Downloadable!] (restricted)
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  10. Andrew Levin & Volker Wieland & John C. Williams, 1998. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Working Papers 6570, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," NBER Working Papers 5893, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Nicoletta Batini & Edward Nelson, . "Optimal horizons for inflation targeting," Bank of England working papers 119, Bank of England. [Downloadable!]
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  13. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  14. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  15. Andrew Levin & Volker Wieland & John Williams, 2000. "The Performance Of Forecast-Based Monetary Policy Rules Under Model Uncertainty," Computing in Economics and Finance 2000 203, Society for Computational Economics.
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  16. Athanasios Orphanides & Simon van Norden, 1999. "The Reliability of Output Gap Estimates in Real Time," Macroeconomics 9907006, EconWPA. [Downloadable!]
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  17. Frank Smets, 2000. "What horizon for price stability," Working Paper Series 24, European Central Bank. [Downloadable!]
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  20. Andrew G. Haldane & Nicoletta Batini, 1998. "Forward-Looking Rules for Monetary Policy," NBER Working Papers 6543, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  21. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  22. Orphanides, Athanasios & Porter, Richard D. & Reifschneider, David & Tetlow, Robert & Finan, Frederico, 2000. "Errors in the measurement of the output gap and the design of monetary policy," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 117-141. [Downloadable!] (restricted)
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  23. Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series 1998-50, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  24. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June. [Downloadable!] (restricted)
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  25. Athanasios Orphanides & David W. Wilcox, 1996. "The opportunistic approach to disinflation," Finance and Economics Discussion Series 96-24, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  26. Athanasios Orphanides, 2001. "Monetary Policy Rules Based on Real-Time Data," American Economic Review, American Economic Association, vol. 91(4), pages 964-985, September. [Downloadable!] (restricted)
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  27. Volker Wieland, 1998. "Monetary policy and uncertainty about the natural unemployment rate," Finance and Economics Discussion Series 1998-22, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  28. Ray C. Fair, 2001. "Actual Federal Reserve policy behavior and interest rate rules," Economic Policy Review, Federal Reserve Bank of New York, issue Mar, pages 61-72. [Downloadable!]
  29. Jeffery D. Amato & Thomas Laubach, 1999. "Forecast-based monetary policy," Research Working Paper 99-10, Federal Reserve Bank of Kansas City. [Downloadable!]
  30. Athanasios Orphanides, 2000. "Activist stabilization policy and inflation: the Taylor rule in the 1970s," Finance and Economics Discussion Series 2000-13, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  31. Nessén, Marianne, 1999. "Targeting Inflation over the Short, Medium and Long Term," Working Paper Series 98, Sveriges Riksbank (Central Bank of Sweden). [Downloadable!]
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  32. Frank Smets, 1998. "Output gap uncertainty: does it matter for the Taylor rule?," BIS Working Papers 60, Bank for International Settlements. [Downloadable!]
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  33. Sack, Brian & Wieland, Volker, 2000. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 205-228. [Downloadable!] (restricted)
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  34. William Kerr & Robert G. King, 1996. "Limits on interest rate rules in the IS model," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 47-75. [Downloadable!]
  35. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12. [Downloadable!]
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