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Shocks and Government Beliefs: The Rise and Fall of American Inflation


  • Thomas Sargent
  • Noah Williams
  • Tao Zha


We use a Bayesian Markov Chain Monte Carlo algorithm to estimate the parameters of a ?true? data-generating mechanism and those of a sequence of approximating models that a monetary authority uses to guide its decisions. Gaps between a true expectational Phillips curve and the monetary authority?s approximating nonexpectational Phillips curve models unleash inflation that a monetary authority that knows the true model would avoid. A sequence of dynamic programming problems implies that the monetary authority?s inflation target evolves as its estimated Phillips curve moves. Our estimates attribute the rise and fall of post- WWII inflation in the United States to an intricate interaction between the monetary authority?s beliefs and economic shocks. Shocks in the 1970s made the monetary authority perceive a tradeoff between inflation and unemployment which ignited big inflation. The monetary authority?s beliefs about the Phillips curve changed in ways that account for former Federal Reserve Chairman Paul Volcker?s conquest of U.S. inflation. (JEL E24, E31, E52, N12)

Suggested Citation

  • Thomas Sargent & Noah Williams & Tao Zha, 2006. "Shocks and Government Beliefs: The Rise and Fall of American Inflation," American Economic Review, American Economic Association, vol. 96(4), pages 1193-1224, September.
  • Handle: RePEc:aea:aecrev:v:96:y:2006:i:4:p:1193-1224 Note: DOI: 10.1257/aer.96.4.1193

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    References listed on IDEAS

    1. Timothy Cogley & Thomas J. Sargent, 2005. "Drift and Volatilities: Monetary Policies and Outcomes in the Post WWII U.S," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 262-302, April.
    2. John Geweke, 1999. "Using simulation methods for bayesian econometric models: inference, development,and communication," Econometric Reviews, Taylor & Francis Journals, vol. 18(1), pages 1-73.
    3. Thomas J. Sargent & Noah Williams, 2005. "Impacts of Priors on Convergence and Escapes from Nash Inflation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 360-391, April.
    4. Peter N. Ireland, 2007. "Changes in the Federal Reserve's Inflation Target: Causes and Consequences," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(8), pages 1851-1882, December.
    5. Timothy Cogley & Thomas J. Sargent, 2005. "The conquest of US inflation: Learning and robustness to model uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 528-563, April.
    6. Douglas Staiger & James H. Stock & Mark W. Watson, 1997. "The NAIRU, Unemployment and Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 33-49, Winter.
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    11. Henry W. Chappell, Jr. & Rob Roy McGregor & Todd A. Vermilyea, 2005. "Committee Decisions on Monetary Policy: Evidence from Historical Records of the Federal Open Market Committee," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262033305, July.
    12. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, July.
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    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit


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