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Why Inflation Rose and Fell: Policymakers' Beliefs and US Postwar Stabilization Policy

  • Giorgio Primiceri

This paper provides an explanation for the run-up of U.S. inflation in the 1960s and 1970s and the sharp disinflation in the early 1980s, which standard macroeconomic models have difficulties in addressing. I present a model in which rational policymakers learn about the behavior of the economy in real time and set stabilization policy optimally, conditional on their current beliefs. The steady state associated with the self-confirming equilibrium of the model is characterized by low inflation. However, prolonged episodes of high inflation ending with rapid disinflations can occur when policymakers underestimate both the natural rate of unemployment and the persistence of inflation in the Phillips curve. I estimate the model using likelihood methods. The estimation results show that the model accounts remarkably well for the evolution of policymakers' beliefs, stabilization policy and the postwar behavior of inflation and unemployment in the United States.

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File URL: http://www.nber.org/papers/w11147.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11147.

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Date of creation: Feb 2005
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Publication status: published as Primiceri, Giorgio. “Why Inflation Rose and Fell: Policymakers’ Beliefs and US Postwar Stabilization Policy.” The Quarterly Journal of Economics 121 (August 2006): 867-901.
Handle: RePEc:nbr:nberwo:11147
Note: ME
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  1. Athanasios Orphanides, 2002. "Monetary policy rules and the Great Inflation," Finance and Economics Discussion Series 2002-8, Board of Governors of the Federal Reserve System (U.S.).
  2. Timothy Cogley & Thomas J. Sargent, 2003. "Drifts and volatilities: monetary policies and outcomes in the post WWII U.S," Working Paper 2003-25, Federal Reserve Bank of Atlanta.
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