A stylized fact of US inflation dynamics is one of extreme persistence and possible unit root behavior. If so, the implications for macroeconomics and monetary policy are somewhat unpalatable. Our econometric analysis proposes a parsimonious representation of the inflation process, the nonlinear ESTAR, rather than the IMA process with time-varying parameters as in Stock and Watson (2007). The empirical results confirm a number of the key features such as regime changes and implicit Federal Reserve inflationtargets. We address the issue of whether the source of the Great Moderation can be ascribed to good luck rather than good policy.
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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number
dp601.