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Noisy Information, Interest Rate Shocks and the Great Moderation

In this paper we quantitatively evaluate the hypothesis that the Great Moderation is partly the result of a less activist monetary policy. We simulate a New Keynesian model where the central bank can only observe a noisy estimate of the output gap and fnd that the less pronounced reaction of the Federal Reserve to output gap uctuations since 1979 can account for half of the reduction in the standard deviation of GDP associated with the Great Moderation. Our simulations are consistent with the empirically documented smaller magnitude and impact of interest rate shocks since the early 1980s.

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File URL: http://www.econ.jku.at/papers/2010/wp1007.pdf
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Paper provided by Department of Economics, Johannes Kepler University Linz, Austria in its series Economics working papers with number 2010-07.

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Length: 28 pages
Date of creation: May 2010
Date of revision:
Handle: RePEc:jku:econwp:2010_07
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  12. Orphanides, Athanasios & Williams, John C., 2007. "Robust monetary policy with imperfect knowledge," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1406-1435, July.
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  18. Giannone, Domenico & Lenza, Michele & Reichlin, Lucrezia, 2008. "Explaining the Great Moderation: it is not the shocks," Working Paper Series 0865, European Central Bank.
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  23. Fabio Canova, 2009. "What Explains The Great Moderation in the U.S.? A Structural Analysis," Journal of the European Economic Association, MIT Press, vol. 7(4), pages 697-721, 06.
  24. Shaghil Ahmed & Andrew Levin & Beth Anne Wilson, 2004. "Recent U.S. Macroeconomic Stability: Good Policies, Good Practices, or Good Luck?," The Review of Economics and Statistics, MIT Press, vol. 86(3), pages 824-832, August.
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