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Output Gap Uncertainty and Monetary Policy During the 1970s

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  • Spencer David E.

    (Brigham Young University)

Abstract

The conduct of monetary policy during the 1970s was greatly complicated by systematic real-time misperceptions of the state of economic activity as measured by the output gap. Employing real-time data and using the Taylor rule as an analytical framework, I explore the implications of utilizing alternative observable proxies for the unobservable output gap. I compare the counterfactual paths for the federal funds rate generated under each proxy with the actual path of the federal funds rate and a benchmark ( "ideal" ) path implied by a full information Taylor rule. Results suggest that these real-time proxies would have resulted in better policy outcomes than actually occurred. Indeed, the federal funds rate path that comes closest to the ideal path occurs when the estimate of the output gap is taken to be zero (its steady-state value) at every point in time. This is equivalent to ignoring output gap information in monetary policy decisions.

Suggested Citation

  • Spencer David E., 2004. "Output Gap Uncertainty and Monetary Policy During the 1970s," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-20, February.
    • Handle: RePEc:bpj:bejmac:v:topics.4:y:2004:i:1:n:2
    DOI: 10.2202/1534-5998.1147
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    References listed on IDEAS

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    1. Hilde Bjørnland & Leif Brubakk & Anne Jore, 2008. "Forecasting inflation with an uncertain output gap," Empirical Economics, Springer, vol. 35(3), pages 413-436, November.

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