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Great Moderation debate: should we be worry about using approximated policy functions?

  • Arturo Ormeno

    (Universitat Pompeu Fabra)

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    Is the evidence favouring a change in the monetary policy rule during the early 80’s biased by the omission of relevant terms in the approximated policy function? Can we use Bayesian estimation of Dynamic Stochastic General Equilibrium (DSGE) models to provide evidence supporting the “good luck” or “good policy” hypotheses as competing explanations of the Great Moderation? In this paper I shed light on the magnitude of the bias generated by the omission of second order terms in the approximated policy functions used in Bayesian econometrics. The results of this study show that this bias is not important for high volatility periods such as the one experimented between the 60’s and 70’s.

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    Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 659.

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    Date of creation: 2008
    Date of revision:
    Handle: RePEc:red:sed008:659
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    Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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    1. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
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    3. Canova, Fabio & Gambetti, Luca & Pappa, Evi, 2006. "The Structural Dynamics of Output Growth and Inflation: Some International Evidence," CEPR Discussion Papers 5878, C.E.P.R. Discussion Papers.
    4. Thomas A. Lubik & Frank Schorfheide, 2004. "Testing for Indeterminacy: An Application to U.S. Monetary Policy," American Economic Review, American Economic Association, vol. 94(1), pages 190-217, March.
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    7. Peter N. Ireland, 1999. "Sticky-Price Models of the Business Cycle: Specification and Stability," Boston College Working Papers in Economics 426, Boston College Department of Economics.
    8. Christopher A. Sims & Tao Zha, 2005. "Were There Regime Switches in U.S. Monetary Policy?," Working Papers 92, Princeton University, Department of Economics, Center for Economic Policy Studies..
    9. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," NBER Technical Working Papers 0282, National Bureau of Economic Research, Inc.
    10. Rabanal, Pau & Rubio-Ramirez, Juan F., 2005. "Comparing New Keynesian models of the business cycle: A Bayesian approach," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1151-1166, September.
    11. Stephen G. Cecchetti & Alfonso Flores-Lagunes & Stefan Krause, 2006. "Assessing the Sources of Changes in the Volatility of Real Growth," NBER Working Papers 11946, National Bureau of Economic Research, Inc.
    12. Karen E. Dynan & Douglas W. Elmendorf & Daniel E. Sichel, 2005. "Can financial innovation help to explain the reduced volatility of economic activity?," Finance and Economics Discussion Series 2005-54, Board of Governors of the Federal Reserve System (U.S.).
    13. Luca Benati, 2008. "Investigating Inflation Persistence Across Monetary Regimes," The Quarterly Journal of Economics, Oxford University Press, vol. 123(3), pages 1005-1060.
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