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

  • Efrem Castelnuovo

    ()

    (Economics University of Padua)

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.

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File URL: http://repec.org/sce2006/up.27644.1138714473.pdf
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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 59.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:59
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  1. Fuhrer, Jeffrey, 2006. "Intrinsic and Inherited Inflation Persistence," MPRA Paper 805, University Library of Munich, Germany.
  2. Jean Boivin & Marc P. Giannoni, 2006. "Has Monetary Policy Become More Effective?," The Review of Economics and Statistics, MIT Press, vol. 88(3), pages 445-462, August.
  3. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  4. Peter N. Ireland, 2004. "Technology Shocks in the New Keynesian Model," NBER Working Papers 10309, National Bureau of Economic Research, Inc.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  6. Athanasios Orphanides & John C. Williams, 2002. "Imperfect knowledge, inflation expectations, and monetary policy," Finance and Economics Discussion Series 2002-27, Board of Governors of the Federal Reserve System (U.S.).
  7. Ignazio Angelloni & Luc Aucremanne & Michael Ehrmann & Jordi Galí & Andrew Levin & Frank Smets, 2005. "New evidence on inflation persistence and price stickiness in the Euro area: Implications for macro modelling," Economics Working Papers 910, Department of Economics and Business, Universitat Pompeu Fabra.
  8. Christopher A. Sims & Tao Zha, 2004. "Were there regime switches in U.S. monetary policy?," Working Paper 2004-14, Federal Reserve Bank of Atlanta.
  9. Rabanal, Pau, 2007. "Does inflation increase after a monetary policy tightening? Answers based on an estimated DSGE model," Journal of Economic Dynamics and Control, Elsevier, vol. 31(3), pages 906-937, March.
  10. Thomas Lubik & Frank Schorfheide, 2002. "Testing for Indeterminacy:An Application to U.S. Monetary Policy," Economics Working Paper Archive 480, The Johns Hopkins University,Department of Economics, revised Jun 2003.
  11. Galí, Jordi & Gertler, Mark & López-Salido, J David, 2001. "European Inflation Dynamics," CEPR Discussion Papers 2684, C.E.P.R. Discussion Papers.
  12. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-86, September.
  13. Paolo Surico, 2005. "Monetary Policy Shifts, Indeterminacy and Inflation Dynamics," Computing in Economics and Finance 2005 313, Society for Computational Economics.
  14. Glenn D. Rudebusch & Jeffrey C. Fuhrer, 2002. "Estimating the Euler equation for output," Working Paper Series 2002-12, Federal Reserve Bank of San Francisco.
  15. Lubik, Thomas A. & Schorfheide, Frank, 2003. "Computing sunspot equilibria in linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 28(2), pages 273-285, November.
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