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US post-war monetary policy: what caused the Great Moderation?




Using indirect inference based on a VAR we confront US data from 1972 to 2007 with a standard New Keynesian model in which an optimal timeless policy is substituted for a Taylor rule. We find the model explains the data both for the Great Acceleration and the Great Moderation. The implication is that changing variances of shocks caused the reduction of volatility. Smaller Fed policy errors accounted for the fall in inflation volatility. Smaller supply shocks accounted for the fall in output volatility and smaller demand shocks for lower interest rate volatility. The same model with differing Taylor rules of the standard sorts cannot explain the data of either episode. But the model with timeless optimal policy could have generated data in which Taylor rule regressions could have been found, creating an illusion that monetary policy was following such rules.

Suggested Citation

  • Minford, Patrick & Ou, Zhirong, 2010. "US post-war monetary policy: what caused the Great Moderation?," Cardiff Economics Working Papers E2010/10, Cardiff University, Cardiff Business School, Economics Section.
  • Handle: RePEc:cdf:wpaper:2010/10

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    References listed on IDEAS

    1. Saeed Al-Muharrami & Kent Matthews, 2009. "Market power versus efficient-structure in Arab GCC banking," Applied Financial Economics, Taylor & Francis Journals, vol. 19(18), pages 1487-1496.
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    More about this item


    Great Moderation; Shocks; Monetary policy; New Keynesian model; Bootstrap; VAR; Indirect inference; Wald statistic;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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