Revisiting the Great Moderation: Policy or Luck?

We investigate the relative roles of monetary policy and shocks in causing the Great Moderation, using indirect inference where a DSGE model is tested for its ability to mimic a VAR describing the data. A New Keynesian model with a Taylor Rule and one with the Optimal Timeless Rule are both tested....

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Bibliographic Details
Published in:Open economies review 2015-04, Vol.26 (2), p.197-223
Main Authors: Minford, Patrick, Ou, Zhirong, Wickens, Michael
Format: Article
Language:English
Subjects:
Development Economics
Economic models
Economic Policy
Economic statistics
Economic theory
Economics
Economics and Finance
European Integration
Federal Reserve monetary policy
Inflation
Interest rates
International Economics
Keynesianism
Macroeconomics/Monetary Economics//Financial Economics
Monetary policy
Monetary theory
Open economies
Phillips curve
Research Article
Studies
Taylor rule
Vector-autoregressive models
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Summary:We investigate the relative roles of monetary policy and shocks in causing the Great Moderation, using indirect inference where a DSGE model is tested for its ability to mimic a VAR describing the data. A New Keynesian model with a Taylor Rule and one with the Optimal Timeless Rule are both tested. The latter easily dominates, whether calibrated or estimated, implying that the Fed’s policy in the 1970s was neither inadequate nor a cause of indeterminacy; it was both optimal and essentially unchanged during the 1980s. By implication it was largely the reduced shocks that caused the Great Moderation—among them monetary policy shocks the Fed injected into inflation.
ISSN:0923-7992
1573-708X
DOI:10.1007/s11079-014-9319-7