Advanced Search
MyIDEAS: Login to save this paper or follow this series

Monetary Policy Mistakes and the Evolution of Inflation Expectations

Contents:

Author Info

  • Athanasios Orphanides
  • John Williams

Abstract

What monetary policy framework, if adopted by the Federal Reserve, would have avoided the Great Inflation of the 1960s and 1970s? We use counterfactual simulations of an estimated model of the U.S. economy to evaluate alternative monetary policy strategies. We show that policies constructed using modern optimal control techniques aimed at stabilizing inflation, economic activity, and interest rates would have succeeded in achieving a high degree of economic stability as well as price stability only if the Federal Reserve had possessed excellent information regarding the structure of the economy or if it had acted as if it placed relatively low weight on stabilizing the real economy. Neither condition held true. We document that policymakers at the time both had an overly optimistic view of the natural rate of unemployment and put a high priority on achieving full employment. We show that in the presence of realistic informational imperfections and with an emphasis on stabilizing economic activity, an optimal control approach would have failed to keep inflation expectations well anchored, resulting in high and highly volatile inflation during the 1970s. Finally, we show that a strategy of following a robust first-difference policy rule would have been highly effective at stabilizing inflation and unemployment in the presence of informational imperfections. This robust monetary policy rule yields simulated outcomes that are close to those seen during the period of the Great Moderation starting in the mid-1980s.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.nber.org/papers/w17080.pdf
Download Restriction: no

Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17080.

as in new window
Length:
Date of creation: May 2011
Date of revision:
Publication status: published as Monetary Policy Mistakes and the Evolution of Inflation Expectations , Athanasios Orphanides, John C. Williams. in The Great Inflation: The Rebirth of Modern Central Banking , Bordo and Orphanides. 2013
Handle: RePEc:nbr:nberwo:17080

Note: POL
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Email:
Web page: http://www.nber.org
More information through EDIRC

Related research

Keywords:

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Lindsey, David E & Orphanides, Athanasios & Rasche, Robert H, 2005. "The Reform of October 1979: How it Happened and Why," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4866, C.E.P.R. Discussion Papers.
  2. Kalchbrenner, J H & Tinsley, Peter A, 1976. "On the Use of Feedback Control in the Design of Aggregate Monetary Policy," American Economic Review, American Economic Association, American Economic Association, vol. 66(2), pages 349-55, May.
  3. Athanasios Orphanides & John Williams, 2004. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Chapters, in: The Inflation-Targeting Debate, pages 201-246 National Bureau of Economic Research, Inc.
  4. Marvin Goodfriend & Robert King, 2005. "The Incredible Volcker Disinflation," NBER Working Papers 11562, National Bureau of Economic Research, Inc.
  5. Athanasios Orphanides, 2002. "Monetary policy rules and the Great Inflation," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2002-8, Board of Governors of the Federal Reserve System (U.S.).
  6. John C. Williams & Andrew T. Levin, 2003. "Robust Monetary Policy with Competing Reference Models," Computing in Economics and Finance 2003, Society for Computational Economics 291, Society for Computational Economics.
  7. Dean Croushore & Tom Stark, 1999. "A real-time data set for macroeconomists," Working Papers 99-4, Federal Reserve Bank of Philadelphia.
  8. Robert J. Tetlow, 2010. "Real-time model uncertainty in the United States: 'Robust' policies put to the test," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2010-15, Board of Governors of the Federal Reserve System (U.S.).
  9. Athanasios Orphanides & John C. Williams, 2006. "Inflation Targeting Under Imperfect Knowledge," Working Papers Central Bank of Chile, Central Bank of Chile 398, Central Bank of Chile.
  10. Athanasios Orphanides & John C. Williams, 2008. "Imperfect Knowledge And The Pitfalls Of Optimal Control Monetary Policy," Working Papers Central Bank of Chile, Central Bank of Chile 499, Central Bank of Chile.
  11. Marc Giannoni & Michael Woodford, 2004. "Optimal Inflation-Targeting Rules," NBER Chapters, in: The Inflation-Targeting Debate, pages 93-172 National Bureau of Economic Research, Inc.
  12. Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Working Papers 050608, University of California-Irvine, Department of Economics.
  13. Orphanides, Athanasios & Williams, John C, 2005. "The Decline of Activist Stabilization Policy: Natural Rate Misperceptions, Learning and Expectations," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4865, C.E.P.R. Discussion Papers.
  14. Orphanides, Athanasios, 2000. "The quest for prosperity without inflation," Working Paper Series, European Central Bank 0015, European Central Bank.
  15. Branch, William A. & Evans, George W., 2006. "A simple recursive forecasting model," Economics Letters, Elsevier, Elsevier, vol. 91(2), pages 158-166, May.
  16. Herbert Stein, 1996. "A Successful Accident: Recollections and Speculations about the CEA," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 10(3), pages 3-21, Summer.
  17. Franco Modigliani & Lucas Papademos, 1975. "Targets for Monetary Policy in the Coming Year," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(1), pages 141-166.
  18. Athanasios Orphanides & John C. Williams, 2002. "Robust monetary policy rules with unknown natural rates," Working Paper Series, Federal Reserve Bank of San Francisco 2003-01, Federal Reserve Bank of San Francisco.
  19. Schmidt-Hebbel, Klaus & Tapia, Matias, 2002. "Inflation targeting in Chile," The North American Journal of Economics and Finance, Elsevier, Elsevier, vol. 13(2), pages 125-146, August.
  20. Dean Croushore, 1993. "Introducing: the survey of professional forecasters," Business Review, Federal Reserve Bank of Philadelphia, Federal Reserve Bank of Philadelphia, issue Nov, pages 3-15.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Athanasios Orphanides, 2011. "New Paradigms in Central Banking?," Working Papers, Central Bank of Cyprus 2011-6, Central Bank of Cyprus.
  2. M. Hashem Pesaran & Ron P Smith, 2014. "Counterfactual Analysis in Macroeconometrics: An Empirical Investigation into the Effects of Quantitative Easing," Birkbeck Working Papers in Economics and Finance, Birkbeck, Department of Economics, Mathematics & Statistics 1406, Birkbeck, Department of Economics, Mathematics & Statistics.
  3. Orphanides, Athanasios, 2010. "Monetary Policy Lessons from the Crisis," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7891, C.E.P.R. Discussion Papers.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:17080. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.