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Escape Dynamics and Policy Specification

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  • Michele Berardi

Abstract

In his monograph The conquest of American inflation (1999) Sargent suggests that the sharp reduction in US inflation that took place under Volker may vindicate the type of econometric policy evaluation famously criticized by Lucas (1976). At the core of this vindication strory are the escape dynamics, recurrent sliding away from the path leading to the time-consistent sub-optimal equilibrium level of inflation. We try to understand here under which conditions this phenomenon arises. In particular, we note that economists, and consequently policymakers, knew long before the Lucas critique that in order to do policy analysis structural models were required. We thus endow our policymaker with a correctly specified model, one that takes explicitly into account the role of expectations. Using such a model, together with a policy that takes expectations as given, the escape dynamics do not appear. But they reappear when long run considerations of policy effects enter into the picture. We thus conclude that what really matters is the way in which the policymaker designs its policy, rather than the econometric specification of the model he uses.

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Bibliographic Info

Paper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 117.

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Length: 27 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:man:cgbcrp:117

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  1. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  2. Wieland, Volker, 2000. "Learning by doing and the value of optimal experimentation," Journal of Economic Dynamics and Control, Elsevier, vol. 24(4), pages 501-534, April.
  3. Robert J. Barro & David B. Gordon, 1984. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  4. Beck, Gunter W. & Wieland, Volker, 2002. "Learning and control in a changing economic environment," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1359-1377, August.
  5. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  6. Robert G. King & Mark W. Watson, 1994. "The post-war U.S. Phillips curve: a revisionist econometric history," Working Paper Series, Macroeconomic Issues 94-14, Federal Reserve Bank of Chicago.
  7. Andrea Gerali & Francesco Lippi, 2002. "On the 'conquest' of inflation," Temi di discussione (Economic working papers) 444, Bank of Italy, Economic Research and International Relations Area.
  8. Cho, In-Koo & Sargent, Thomas J., 2000. "Escaping Nash inflation," Working Paper Series 0023, European Central Bank.
  9. Ireland, Peter N., 1999. "Does the time-consistency problem explain the behavior of inflation in the United States?," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 279-291, October.
  10. Friedman, Benjamin M., 1979. "Optimal expectations and the extreme information assumptions of `rational expectations' macromodels," Journal of Monetary Economics, Elsevier, vol. 5(1), pages 23-41, January.
  11. Bennett T. McCallum, 1996. "Crucial Issues Concerning Central Bank Independence," NBER Working Papers 5597, National Bureau of Economic Research, Inc.
  12. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
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Cited by:
  1. Dmitri Kolyuzhnov & Anna Bogomolova & Sergey Slobodyan, 2006. "Escape Dynamics: A Continuous—Time Approximation," CERGE-EI Working Papers wp285, The Center for Economic Research and Graduate Education - Economic Institute, Prague.

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