Business cycles and monetary regimes in the U.S. (1960 – 2014): A plea for monetary stability

It is still highly debated whether the Fed took sufficiently into account the rapid increase in both financial and real asset prices as well as money growth in the framing of monetary policy decisions in the years prior to the outbreak of the Global Financial Crisis; something similar occurred in the 1970s as regard the slow and insufficient response of the Fed to the growth of CPI prices. In our view, these two episodes are prime examples of how the absence of a more comprehensive monetary strategy has resulted in a case-by-case decision-making policy by the Fed lacking in consistency and effectiveness over the long term. In this respect, two elements of the central bank strategy become key: the choice of the information set the monetary authorities process and use to make policy decisions and the (main) economic model used to process that information. In this paper we consider a wide range of indicators to identify the dynamics and interaction between several output and price indicators (broadly defined to include CPI, industrial and asset prices) along the business cycle. In particular, we adopt unobserved component models to estimate and analyse the cyclical common factors of output measures, inflation and asset prices, interest rates (both short and longer term), and narrow and broad money growth measures, since 1960 to 2014 in the US. Once estimated, we analyse the correlations between these common factors and their changes in order to identify common behavioural patterns amongst them along the cycle. This analysis will result in a ‘core information set’ for the Fed suitable to frame and possibly implement a more stable monetary policy throughout the business cycle.