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Monetary Rules, Indeterminacy, and the Business-Cycle Stylised Facts

Listed author(s):
  • Luca Benati

Several papers have documented how the reaction function of the U.S. monetary authority has been passive, and destabilising, before Volcker"s appointment, and active and stabilising since then. In this paper we first compare the two sub-periods in terms of several key business-cycle 'stylised facts'. The latter period appears to be characterised by a lower inflation persistence; a smaller volatility of reduced-form innovations to both inflation and real GDP growth; and a systematically smaller amplitude of business-cycle frequency fluctuations. Working with the Smets-Wouters (2003) sticky-price, sticky-wage DSGE model of the U.S. economy, we then investigate how such stylised facts change systematically with changes in the parameters of a simple forward-looking monetary rule. We solve the model under indeterminacy via the procedure introduced by Lubik and Schorfheide (2003). The determinacy and indeteminacy regions appear to be characterised by markedly different sets of stylised facts. In several cases the relationship between the parameters of the monetary rule and key stylised facts under indeterminacy is a mirror image of what it is under determinacy: both inflation persistence and the volatility of its reduced-form innovations, for example, are increasing in the coefficient on inflation under indeterminacy, decreasing under determinacy. We finally compare the facts identified in the data with those generated by the model conditional on estimated monetary rules.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 83.

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Date of creation: 11 Aug 2004
Handle: RePEc:sce:scecf4:83
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