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New economy - new policy rules?

  • James Bullard
  • Eric Schaling

The U.S. economy appears to have experienced a pronounced shift toward higher productivity over the last five years or so. We wish to understand the implications of such shifts for the structure of optimal monetary policy rules in simple dynamic economies. Accordingly, we begin with a standard economy in which a version of the Taylor rule constitutes the optimal monetary policy for a given inflation target and a given level of productivity. We augment this model with regime switching in productivity, and calculate the optimal monetary policy rule in the altered environment. We find that in the altered environment, a rule that incorporates leading indicators about regimes significantly outperforms the Taylor rule. We use this result to comment on the "new economy" events of the 1990s and the "stagflation" events of the 1970s form the perspective of our model.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2000-019.

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Date of creation: 2000
Date of revision:
Publication status: Published in Federal Reserve Bank of St. Louis Review, September/October 2001, 83(5), pp. 57-66
Handle: RePEc:fip:fedlwp:2000-019
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  1. Lars E O Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Bank of England working papers 56, Bank of England.
  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  3. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  4. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
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