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Taylor rules and the Great Inflation

  • Nikolsko-Rzhevskyy, Alex
  • Papell, David H.

Can US monetary policy in the 1970s be described by a stabilizing Taylor rule when policy is evaluated with real-time inflation and output gap data? Using economic research on the full employment level of unemployment and the natural rate of unemployment published between 1970 and 1977 to construct real-time output gap measures for periods of peak unemployment, we find that the Federal Reserve did not follow a Taylor rule if appropriate measures are used. We estimate Taylor rules and find no evidence that monetary policy stabilized inflation, even allowing for changes in the inflation target. While monetary policy was stabilizing with respect to inflation forecasts, the forecasts systematically under-predicted inflation following the 1970s recessions and this does not constitute evidence of stabilizing policy. We also find that the Federal Reserve responded too strongly to negative output gaps.

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Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 34 (2012)
Issue (Month): 4 ()
Pages: 903-918

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Handle: RePEc:eee:jmacro:v:34:y:2012:i:4:p:903-918
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622617

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