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Output Gap Uncertainty and Monetary Policy During the 1970s

Listed author(s):
  • Spencer David E.

    ()

    (Brigham Young University)

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.

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Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 4 (2004)
Issue (Month): 1 (February)
Pages: 1-20

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Handle: RePEc:bpj:bejmac:v:topics.4:y:2004:i:1:n:2
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  1. English William B. & Nelson William R. & Sack Brian P., 2003. "Interpreting the Significance of the Lagged Interest Rate in Estimated Monetary Policy Rules," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-18, April.
  2. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  3. Stark, Tom & Croushore, Dean, 2002. "Forecasting with a real-time data set for macroeconomists," Journal of Macroeconomics, Elsevier, vol. 24(4), pages 507-531, December.
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  5. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
  6. Sack, Brian & Wieland, Volker, 2000. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 205-228.
  7. Andrew T.. Levin & Volker Wieland & John Williams, 1999. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Chapters, in: Monetary Policy Rules, pages 263-318 National Bureau of Economic Research, Inc.
  8. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  9. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  10. Perez, Stephen J., 2001. "Looking back at forward-looking monetary policy," Journal of Economics and Business, Elsevier, vol. 53(5), pages 509-521.
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