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An Overhaul of Fed Doctrine: Nominal Income and the Great Moderation

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  • Hendrickson, Joshua

Abstract

The Great Moderation is often characterized by the decline in the variability of output and inflation from earlier periods. While a multitude of explanations for the Great Moderation exist, notable research has focused on the role of monetary policy. Specifically, early evidence suggested that the increased stability has been associated with monetary policy that responded much more strongly to rising inflation. Recent evidence casts doubt on this change in monetary policy. An alternative hypothesis is that the change in monetary policy was the result of a change in doctrine; specifically the rejection of the view that inflation was largely a cost-push phenomenon. As a result, this alternative hypothesis suggests that the change in monetary policy beginning in 1979 is reflected in the Federal Reserve's response to movements in nominal income rather than inflation as previously argued. I provide evidence for this hypothesis by estimating the parameters of a monetary policy rule in which policy adjusts to forecasts of nominal GDP for the pre- and post-Volcker eras. Finally, I embed the rule in two dynamic stochastic general equilibrium models with gradual price adjustment to determine whether the overhaul of doctrine can explain the reduction in the volatility of inflation and the output gap.

Suggested Citation

  • Hendrickson, Joshua, 2010. "An Overhaul of Fed Doctrine: Nominal Income and the Great Moderation," MPRA Paper 20346, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:20346
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    References listed on IDEAS

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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Is the Fed a firefighter or an arsonist?, by Scott Sumner
      by ? in Econlog on 2016-10-20 18:20:17

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    Cited by:

    1. Hendrickson, Joshua R., 2014. "Redundancy Or Mismeasurement? A Reappraisal Of Money," Macroeconomic Dynamics, Cambridge University Press, vol. 18(7), pages 1437-1465, October.

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    More about this item

    Keywords

    monetary policy rules; real-time data; Greenbook forecasts; nominal income target; Great Moderation;
    All these keywords.

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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