Targets, Policy Lags and Sticky Prices in a Two-Equation Model of US Stabilization Policy
AbstractCarlin and Soskice (2005) advocate a 3-equation model of stabilization policy. One equation is a monetary reaction rule MR derived by assuming that governments have performance objectives, but are constrained by a Phillips curve PC. Central banks attempt to implement these objectives by setting interest rates along an IS curve. They label this the IS-PC-MR model. Observing that governments have more tools than just the interest rate, we drop the IS equation, simplifying their model to 2 equations. Adding a random walk model of the unobserved potential growth, we develop their PC-MR model into a state space specification of the short-run political economy. This is an appropriate econometric method because it incorporates recursive forecasts of unobservable state variables based on contemporaneous information measured with real-time data. Our results are generally consistent with US economic history. One qualification is that governments are more likely to target growth rates than output gaps. Another is that policy affects outcomes after a single lag. This assumption fits the data better than an alternative double-lag timing: one lag for output, plus a second for inflation has been proposed. We also infer that inflation expectations are more likely to be backward rather than forward looking.
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Bibliographic InfoPaper provided by University of Utah, Department of Economics in its series Working Paper Series, Department of Economics, University of Utah with number 2011_03.
Length: 32 pages
Date of creation: 2011
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new Keynesian stabilization; policy targets; microfoundations; real-time data;
Find related papers by JEL classification:
- E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
- E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-02-26 (All new papers)
- NEP-CBA-2011-02-26 (Central Banking)
- NEP-MAC-2011-02-26 (Macroeconomics)
- NEP-MON-2011-02-26 (Monetary Economics)
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