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Monetary Policy Switch, the Taylor Curve, and the Great Moderation

Author

Listed:
• Efrem Castelnuovo

Abstract

This paper employs a standard new Keynesian model to compute the inflation/output volatility frontier, i.e. the "Taylor curve". The computation is performed both under equilibrium uniqueness and under indeterminacy. While under uniqueness the Taylor curve looks like expected - i.e. a monotonically decreasing curve in the ($\sigma x$, $\sigma \Pi$) diagram -, under indeterminacy a new result arises. We find that the tighter is the monetary policy, the higher is the inflation/output gap volatility. This is due to impact of systematic monetary policy on inflation and output persistence. In fact, under indeterminacy a more aggressive monetary policy causes an increase in inflation persistence, and augments its volatility. The effects on output tend to be of opposite sign. This finding is robust to different parameterization of the DSGE new-Keynesian monetary model employed. This result i) offers support the move from "passive" to "active" monetary policy as one of the possible rationales for the Great Moderation, ii) underlines the need of a deeper understanding of the link between systematic monetary policy and macroeconomic persistence, and iii) warns against sub-samples pooling when performing macroeconometric analysis.

Suggested Citation

• Efrem Castelnuovo, 2006. "Monetary Policy Switch, the Taylor Curve, and the Great Moderation," Computing in Economics and Finance 2006 59, Society for Computational Economics.
• Handle: RePEc:sce:scecfa:59
as

File URL: http://repec.org/sce2006/up.27644.1138714473.pdf

References listed on IDEAS

as
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Citations

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Cited by:

1. Olson, Eric & Enders, Walter & Wohar, Mark E., 2012. "An empirical investigation of the Taylor curve," Journal of Macroeconomics, Elsevier, vol. 34(2), pages 380-390.

Keywords

Taylor principle; Taylor curve; new Keynesian model; indeterminacy; persistence;

JEL classification:

• E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
• E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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