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Shocks and government beliefs: the rise and fall of American inflation

  • Thomas J. Sargent
  • Noah Williams
  • Tao Zha

The authors use a Bayesian Markov chain Monte Carlo algorithm to estimate a model that allows temporary gaps between a true expectational Phillips curve and the monetary authority’s approximating nonexpectational Phillips curve. A dynamic programming problem implies that the monetary authority’s inflation target evolves as its estimated Phillips curve moves. The authors’ estimates attribute the rise and fall of post-World War II inflation in the United States to an intricate interaction between the monetary authority’s beliefs and economic shocks. Shocks in the 1970s altered the monetary authority’s estimates and made it misperceive the tradeoff between inflation and unemployment. That misperception caused a sharp rise in inflation in the 1970s. The authors’ estimates indicate that policy makers updated their beliefs continuously. By the 1980s, policy makers’ beliefs about the Phillips curve had changed enough to account for Fed chairman Paul Volcker’s conquest of U.S. inflation in the early 1980s.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta Working Paper with number 2004-22.

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Date of creation: 2004
Date of revision:
Handle: RePEc:fip:fedawp:2004-22
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  1. James D. Hamilton & Daniel F. Waggoner & Tao Zha, 2007. "Normalization in Econometrics," Econometric Reviews, Taylor & Francis Journals, vol. 26(2-4), pages 221-252.
  2. Ireland, Peter N., 1999. "Does the time-consistency problem explain the behavior of inflation in the United States?," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 279-291, October.
  3. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  4. Peter N. Ireland, 2005. "Changes in the Federal Reserve's inflation target: causes and consequences," Working Papers 05-13, Federal Reserve Bank of Boston.
  5. Cho, In-Koo & Sargent, Thomas J., 2000. "Escaping Nash inflation," Working Paper Series 0023, European Central Bank.
  6. King, Robert G. & Watson, Mark W., 1994. "The post-war U.S. phillips curve: a revisionist econometric history," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 41(1), pages 157-219, December.
  7. John F. Geweke, 1998. "Using simulation methods for Bayesian econometric models: inference, development, and communication," Staff Report 249, Federal Reserve Bank of Minneapolis.
  8. Christopher A. Sims & Tao Zha, 1996. "Bayesian methods for dynamic multivariate models," FRB Atlanta Working Paper 96-13, Federal Reserve Bank of Atlanta.
  9. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, June.
  10. Thomas J. Sargent & Noah Williams, 2003. "Impacts of priors on convergence and escapes from Nash inflation," FRB Atlanta Working Paper 2003-14, Federal Reserve Bank of Atlanta.
  11. Timothy Cogley & Thomas J. Sargent, 2003. "Drifts and volatilities: monetary policies and outcomes in the post WWII U.S," FRB Atlanta Working Paper 2003-25, Federal Reserve Bank of Atlanta.
  12. Henry W. Chappell, Jr. & Rob Roy McGregor & Todd A. Vermilyea, 2005. "Committee Decisions on Monetary Policy: Evidence from Historical Records of the Federal Open Market Committee," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262033305, June.
  13. Cogley, Timothy & Sargent, Thomas J., 2005. "The conquest of U.S. inflation: learning and robustness to model uncertainty," Working Paper Series 0478, European Central Bank.
  14. William Poole & Robert H. Rasche, 2002. "Flation," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 1-6.
    • William Poole, 2002. "Flation," Speech 49, Federal Reserve Bank of St. Louis.
  15. Douglas Staiger & James H. Stock & Mark W. Watson, 1997. "The NAIRU, Unemployment and Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 33-49, Winter.
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