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Testing for Indeterminacy:An Application to U.S. Monetary Policy

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  • Thomas Lubik
  • Frank Schorfheide

Abstract

This paper considers a prototypical monetary business cycle model for the U.S. economy, in which the equilibrium is undetermined if monetary policy is �inactive? In previous multivariate studies it has been common practice to restrict parameter estimates to values for which the equilibrium is unique. We show how the likelihood-based estimation of dynamic stochastic general equilibrium models can be extended to allow for indeterminacies and sunspot fluctuations. We propose a posterior odds test for the hypothesis that the data are best explained by parameters that imply determinacy. Our empirical results show that the Volcker-Greenspan policy regime is consistent with determinacy, whereas the pre-Volcker regime is not. We find that before 1979 non-fundamental sunspot shocks may have contributed significantly to inflation and interest rate volatility, but essentially did not affect output fluctuations.

Suggested Citation

  • Thomas Lubik & Frank Schorfheide, 2002. "Testing for Indeterminacy:An Application to U.S. Monetary Policy," Economics Working Paper Archive 480, The Johns Hopkins University,Department of Economics, revised Jun 2003.
  • Handle: RePEc:jhu:papers:480
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