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Regime Switches, Agents' Beliefs, and Post-World War II U.S. Macroeconomic Dynamics

  • Francesco Bianchi

The evolution of inflation and output over the last 50 years are examined through the lense of a micro-founded model that allows for changes in the behavior of the Federal Reserve and in the volatility of structural shocks. Agents are aware of the possibility of regime changes and their beliefs have an impact on the law of motion underlying the macroeconomy. The results support the view that there were regime switches in the conduct of monetary policy. However, behavior of the Federal Reserve is identified by repeated fluctuations between a Hawk- and a Dove-regime, instead of by the traditional pre- and post-Volcker structure. Counterfactual simulations show that if agents had anticipated the appointment of an extremely conservative Chairman, inflation would not have reached the peaks of the late 70s and the inflation-output trade-off would have been less severe. These "beliefs counterfactuals" are new in the literature. Finally, the paper provides a Bayesian algorithm to handle the technical difficulties that arise in rational expectations model with Markov-switching regimes.

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Paper provided by Duke University, Department of Economics in its series Working Papers with number 10-39.

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Length: 60
Date of creation: 2010
Date of revision:
Handle: RePEc:duk:dukeec:10-39
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