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Natural rate doubts

Author

Listed:
  • Beyer, Andreas
  • Farmer, Roger E. A.

Abstract

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

Suggested Citation

  • Beyer, Andreas & Farmer, Roger E. A., 2002. "Natural rate doubts," Working Paper Series 121, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:2002121
    Note: 336354
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    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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