IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Inflation in the 1970s in the U.S.: Misspecification, Learning and Sunspots

  • Peter von zur Muehlen
  • Robert J. Tetlow

In the late 1960s and into the 1970s, the United States experienced a burst of inflation the origins of which seemed hard to uncover. This paper advances the idea that the Fed simply got the model wrong. We assume that the true model of the economy is a variant of the standard New Keynesian model, but the Fed estimates its Phillips curve with a reduced-form equation, consistent with common practice. We show that a central bank that learns its model by recursive least squares would have arrived at the erroneous conclusion that its output-inflation trade-off was better than is truly the case. This statistical inference error induces a policy error that is serious enough to induce the sunspot equilibrium that Clarida, Gali and Gertler (1999) argue was true in the 1970s. The Volcker disinflation is then seen as a bold stroke to rule out sunspot equilibria and restore stability of inflation expectations. An implication of this is that the observed higher volatility of the economy in the 1970s, in comparison with the period after the Volcker disinflation, is really a manifestation of having erroneously assumed away sunspots which shows up as non-constant variances of fundamental shocks during the earlier period.

To our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 240.

as
in new window

Length:
Date of creation: 11 Aug 2004
Date of revision:
Handle: RePEc:sce:scecf4:240
Contact details of provider: Web page: http://comp-econ.org/
Email:


More information through EDIRC

No references listed on IDEAS
You can help add them by filling out this form.

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:sce:scecf4:240. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.