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Policy Switch And The Great Moderation: The Role Of Equilibrium Selection


  • Castelnuovo, Efrem


“Good policy” and “good luck” have been identified as two of the possible drivers of the “Great Moderation,” but their relative importance is still widely debated. This paper investigates the role played by equilibrium selection under indeterminacy in the assessment of their relative merits. We contrast the outcomes of counterfactual simulations conditional on the “continuity” selection strategy–largely exploited by the literature–with those obtained with a novel “sign restriction” based strategy. Our results suggest that conclusions achieved under “continuity” are not necessarily robust to the selection of different–still economically sensible–equilibria. According to our simulations, the switch to a hawkish systematic monetary policy may very well induce an increase in output volatility. Hence, our sign restriction–selection strategy “resurrects” the inflation–output policy tradeoff.

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  • Castelnuovo, Efrem, 2012. "Policy Switch And The Great Moderation: The Role Of Equilibrium Selection," Macroeconomic Dynamics, Cambridge University Press, vol. 16(03), pages 449-471, June.
  • Handle: RePEc:cup:macdyn:v:16:y:2012:i:03:p:449-471_00

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    References listed on IDEAS

    1. Tobias, Justin & Zellner, Arnold, 2000. "A Note on Aggregation, Disaggregation and Forecasting Performance," Staff General Research Papers Archive 12024, Iowa State University, Department of Economics.
    2. Veloce, William & Zellner, Arnold, 1985. "Entry and empirical demand and supply analysis for competitive industries," Journal of Econometrics, Elsevier, vol. 30(1-2), pages 459-471.
    3. Zellner,Arnold & Palm,Franz C. (ed.), 2004. "The Structural Econometric Time Series Analysis Approach," Cambridge Books, Cambridge University Press, number 9780521814072, March.
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    Cited by:

    1. Chen, Xiaoshan & Kirsanova, Tatiana & Leith, Campbell, 2017. "How optimal is US monetary policy?," Journal of Monetary Economics, Elsevier, vol. 92(C), pages 96-111.
    2. Castelnuovo, Efrem, 2010. "Trend inflation and macroeconomic volatilities in the post-WWII U.S. economy," The North American Journal of Economics and Finance, Elsevier, vol. 21(1), pages 19-33, March.
    3. Castelnuovo, Efrem, 2016. "Modest macroeconomic effects of monetary policy shocks during the great moderation: An alternative interpretation," Journal of Macroeconomics, Elsevier, vol. 47(PB), pages 300-314.
    4. Hahn, Volker, 2014. "Transparency In Monetary Policy, Signaling, And Heterogeneous Information," Macroeconomic Dynamics, Cambridge University Press, vol. 18(02), pages 369-394, March.

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