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Why Inflation Rose and Fell: Policy-Makers' Beliefs and U. S. Postwar Stabilization Policy

Listed author(s):
  • Giorgio E. Primiceri

This paper provides an explanation for the run-up of U. S. inflation in the 1960s and 1970s and the sharp disinflation in the early 1980s, which standard macroeconomic models have difficulties in addressing. I present a model in which rational policy-makers learn about the behavior of the economy in real time and set stabilization policy optimally, conditional on their current beliefs. The steady state associated with the self-confirming equilibrium of the model is characterized by low inflation. However, prolonged episodes of high inflation ending with rapid disinflations can occur when policy-makers underestimate both the natural rate of unemployment and the persistence of inflation in the Phillips curve. I estimate the model using likelihood methods. The estimation results show that the model accounts remarkably well for the evolution of policy-makers' beliefs, stabilization policy, and the postwar behavior of inflation and unemployment in the United States.

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File URL: http://hdl.handle.net/10.1162/qjec.121.3.867
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Article provided by Oxford University Press in its journal The Quarterly Journal of Economics.

Volume (Year): 121 (2006)
Issue (Month): 3 ()
Pages: 867-901

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Handle: RePEc:oup:qjecon:v:121:y:2006:i:3:p:867-901.
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  1. Timothy Cogley & Thomas J. Sargent, 2005. "Drift and Volatilities: Monetary Policies and Outcomes in the Post WWII U.S," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 262-302, April.
  2. Athanasios Orphanides, 2002. "Monetary-Policy Rules and the Great Inflation," American Economic Review, American Economic Association, vol. 92(2), pages 115-120, May.
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