Inflation in the 1970s in the U.S.: Misspecification, Learning and Sunspots
AbstractIn the late 1960s and into the 1970s, the United States experienced a burst of inflation the origins of which seemed hard to uncover. This paper advances the idea that the Fed simply got the model wrong. We assume that the true model of the economy is a variant of the standard New Keynesian model, but the Fed estimates its Phillips curve with a reduced-form equation, consistent with common practice. We show that a central bank that learns its model by recursive least squares would have arrived at the erroneous conclusion that its output-inflation trade-off was better than is truly the case. This statistical inference error induces a policy error that is serious enough to induce the sunspot equilibrium that Clarida, Gali and Gertler (1999) argue was true in the 1970s. The Volcker disinflation is then seen as a bold stroke to rule out sunspot equilibria and restore stability of inflation expectations. An implication of this is that the observed higher volatility of the economy in the 1970s, in comparison with the period after the Volcker disinflation, is really a manifestation of having erroneously assumed away sunspots which shows up as non-constant variances of fundamental shocks during the earlier period.
Download InfoTo our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
Bibliographic InfoPaper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 240.
Date of creation: 11 Aug 2004
Date of revision:
inflation; monetary policy; learning; misspecification; sunspots;
Other versions of this item:
- Peter von zur Muehlen & Robert J. Tetlow, 2003. "Inflation in the 1970s in the U.S.: misspecification, learning and sunspots," Computing in Economics and Finance 2003 126, Society for Computational Economics.
- C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral 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: (Christopher F. Baum).
If references are entirely missing, you can add them using this form.