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Natural rate doubts

Listed author(s):
  • Beyer, Andreas
  • Farmer, Roger E.A.

We study the low frequency comovements in unemployment, inflation and the federal funds rate in the U.S. From 1970 through 1979 all three series trended up together; after 1979 they all trended down. The conventional explanation for the buildup of inflation in the 1970's is that the Fed reacted to an increase in the natural rate of unemployment by conducting an overly passive monetary policy. We show that this explanation is difficult to reconcile with the observed comovement of the fed funds rate and inflation. We argue instead that the source of the inflation buildup in the 1970's was a downward drift in the real interest rate that was translated into a simultaneous increase in unemployment and inflation by passive Fed policy. Our explanation relies on the existence in the data of an upward sloping long run Phillips curve. JEL Classification: C32, E3, E43, E58

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 31 (2007)
Issue (Month): 3 (March)
Pages: 797-825

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Handle: RePEc:eee:dyncon:v:31:y:2007:i:3:p:797-825
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Jess Benhabib & Roger Farmer, 1998. "The Monetary Transmission Mechanism," Levine's Working Paper Archive 2055, David K. Levine.
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  4. Robert G. King & Mark W. Watson, 1992. "Testing long run neutrality," Working Paper Series, Macroeconomic Issues 92-18, Federal Reserve Bank of Chicago.
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  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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  9. Orphanides, Athanasios & Williams, John C., 2005. "The decline of activist stabilization policy: Natural rate misperceptions, learning, and expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1927-1950, November.
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  12. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
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  31. repec:fth:starer:9613 is not listed on IDEAS
  32. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
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