Hostname: page-component-586b7cd67f-rcrh6 Total loading time: 0 Render date: 2024-11-27T19:22:10.707Z Has data issue: false hasContentIssue false
  • English
  • Français

POLICY RULES, REGIME SWITCHES, AND TREND INFLATION: AN EMPIRICAL INVESTIGATION FOR THE UNITED STATES

Published online by Cambridge University Press:  20 November 2012

Efrem Castelnuovo ,
Luciano Greco  and
Davide Raggi
Efrem Castelnuovo*
Affiliation:
University of Padua and Bank of Finland
Luciano Greco
Affiliation:
University of Padua
Davide Raggi
Affiliation:
University of Bologna and Johns Hopkins University (SAIS Centre)
*
Address correspondence to: Efrem Castelnuovo, University of Padua and Bank of Finland, via del Santo 33, I-35123; e-mailt: [email protected].
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper estimates Taylor rules featuring instabilities in policy parameters and switches in policy shocks’ volatility for the post-World War II (WWII) U.S. economy. We contrast a rule embedding a fixed-inflation target with another featuring trend inflation, i.e., a time-varying inflation target. The rule embedding trend inflation turns out to be (a) empirically superior according to a marginal likelihood-based comparison and (b) more able to pin down some relevant episodes of the post-WWII U.S. monetary policy history. Estimates conducted with Greenbook data confirm the empirical superiority of the rule featuring a time-varying inflation target. A comparison with recently published estimates of trend inflation is also conducted.

Keywords

Policy SwitchesHeteroskedasticityTrend InflationInflation Gap PersistenceMarkov-Switching Models
Type
Articles
Information
Macroeconomic Dynamics , Volume 18 , Issue 4 , June 2014 , pp. 920 - 942
Copyright
Copyright © Cambridge University Press 2012 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

REFERENCES

Aruoba, S. B. and Schorfheide, F. (2011) Sticky prices versus monetary frictions: An estimation of policy trade-offs. American Economic Journal: Macroeconomics 3, 60–90.Google Scholar
Ascari, G. and Ropele, T. (2007) Optimal monetary policy under low trend inflation. Journal of Monetary Economics 54, 2568–2583.CrossRefGoogle Scholar
Ascari, G. and Ropele, T. (2009) Trend inflation, Taylor principle and indeterminacy. Journal of Money, Credit and Banking 41 (8), 1557–1584.Google Scholar
Bianchi, F. (in press) Regime switches, agents' beliefs, and post-World War II U.S. macroeconomic dynamics. Review of Economic Studies.Google Scholar
Carboni, G. and Ellison, M. (2009) The great inflation and the Greenbook. Journal of Monetary Economics 56 (6), 831–841.Google Scholar
Castelnuovo, E. (2003) Taylor rules, omitted variables, and interest rate smoothing in the US. Economics Letters 81 (1), 55–59.CrossRefGoogle Scholar
Castelnuovo, E. (2007) Taylor rules and interest rate smoothing in the Euro area. Manchester School 75 (1), 1–16.CrossRefGoogle Scholar
Castelnuovo, E. (2010) Tracking U.S. inflation expectations with domestic and global determinants. Journal of International Money and Finance 29 (7), 1340–1356.Google Scholar
Castelnuovo, E. (2012a) Estimating the evolution of money's role in the U.S. monetary business cycle. Journal of Money, Credit and Banking 44 (1), 23–52.CrossRefGoogle Scholar
Castelnuovo, E. (2012b) Policy switch and the Great Moderation: The role of equilibrium selection. Macroeconomic Dynamics 16 (3), 449–471.Google Scholar
Castelnuovo, E. (2012c) Testing the structural interpretation of the price puzzle with a cost channel model. Oxford Bulletin of Economics and Statistics 74 (3), 425–452.Google Scholar
Castelnuovo, E. and Surico, P. (2010) Monetary policy shifts, inflation expectations and the price puzzle. Economic Journal 120 (549), 1262–1283.Google Scholar
Chib, S. and Jeliazkov, I. (2001) Marginal likelihood from the Metropolis–Hastings output. Journal of the American Statistical Association 96, 270–281.Google Scholar
Clarida, R., Gal, J., and Gertler, M. (1998) Monetary policy rules in practice: Some international evidence. European Economic Review 42 (6), 1033–1067.Google Scholar
Clarida, R., Gal, J., and Gertler, M. (2000) Monetary policy rules and macroeconomic stability: Evidence and some theory. Quarterly Journal of Economics 115, 147–180.Google Scholar
Cogley, T., Primiceri, G. E., and Sargent, T. (2010) Inflation-gap persistence in the U.S. American Economic Journal: Macroeconomics 2 (1), 43–69.Google Scholar
Cogley, T. and Sargent, T. (2005) The conquest of U.S. inflation: Learning and robustness to model uncertainty. Review of Economic Dynamics 8, 528–563.Google Scholar
Cogley, T. and Sbordone, A. (2008) Trend inflation, indexation, and inflation persistence in the new Keynesian Phillips curve. American Economic Review 98 (5), 2101–2126.CrossRefGoogle Scholar
Coibion, O. and Gorodnichenko, Y. (2011) Monetary policy, trend inflation and the Great Moderation: An alternative interpretation. American Economic Review 101, 341–370.CrossRefGoogle Scholar
Davig, T. and Doh, T. (2009) Monetary Policy Regime Shifts and Inflation Persistence. Working paper 08-16, Federal Reserve Bank of Kansas City.Google Scholar
Davig, Y. and Leeper, E. (2006) Fluctuating macro policies and the fiscal theory. NBER Macroeconomics Annual, 247–298.Google Scholar
Doornik, J. A. (2001) Ox: An Object-Oriented Matrix Programming Language. London: Timberlake Consultants Press.Google Scholar
Favero, C. and Monacelli, T. (2005) Fiscal Policy Rules and Regime (In)Stability: Evidence from the U.S. Mimeo, Bocconi University and IGIER.Google Scholar
Frühwirth-Schnatter, S. (2006) Finite Mixtures and Markov Switching Models. New York: Springer.Google Scholar
Gelfand, A. and Dey, D. (1994) Bayesian model choice: Asymptotics and exact calculations. Journal of the Royal Statistical Society: Series B 56, 501–514.Google Scholar
Gerlach, S. and Schnabel, G. (2000) The Taylor rule and interest rates in the EMU area. Economics Letters 67 (2), 165–171.Google Scholar
Geweke, J. (1999) Using simulation methods for Bayesian econometric models: Inference, development and communication. Econometric Reviews 18, 1–73.Google Scholar
Golinelli, R. and Rovelli, R. (2003) Monetary policy transmission, interest rate rules and inflation targeting in three transition economies. Journal of Banking and Finance 29, 183–201.Google Scholar
Hamilton, J. (1989) A new approach to the economic analysis of nonstationary time series and the business cycle. Econometrica 57, 357–384.CrossRefGoogle Scholar
Hamilton, J., Waggoner, D., and Zha, T. (2007) Normalization in econometrics. Econometric Reviews 26, 221–252.CrossRefGoogle Scholar
Han, C. and Carlin, B. (2001) MCMC methods for computing Bayes factors: A comparative review. Journal of the American Statistical Association 96, 1122–1132.CrossRefGoogle Scholar
Ireland, P. (2007) Changes in Federal Reserve's inflation target: Causes and consequences. Journal of Money, Credit and Banking 39 (8), 1851–1882.Google Scholar
Justiniano, A. and Primiceri, G. (2008) The time-varying volatility of macroeconomic fluctuations. American Economic Review 98 (3), 604–641.Google Scholar
Kim, C. and Nelson, C. (1999) State-Space Models with Regime-Switching: Classical and Gibbs Sampling Approaches with Applications. Cambridge, MA: MIT Press.Google Scholar
Kozicki, S. and Tinsley, P. (2005) Permanent and transitory policy shocks in an empirical macro model with asymmetric information. Journal of Economic Dynamics and Control 29, 1985–2015.Google Scholar
Kozicki, S. and Tinsley, P. (2009) Perhaps the 1970s FOMC did what it said it did. Journal of Monetary Economics 56, 842–855.Google Scholar
Leeper, E. (1991) Equilibria under “active” and “passive” monetary and fiscal policies. Journal of Monetary Economics 27, 129–147.Google Scholar
Liu, Z., Waggoner, D., and Zha, T. (2011) Sources of macroeconomic fluctuations: A regime-switching DSGE approach. Quantitative Economics 2 (2), 251–301.CrossRefGoogle Scholar
Lubik, T. and Schorfheide, F. (2004) Testing for indeterminacy: An application to U.S. monetary policy. American Economic Review 94 (1), 190–217.CrossRefGoogle Scholar
Milani, F. (2009) Learning and the Evolution of the Fed's Inflation Target. Mimeo, University of California at Irvine.Google Scholar
Orphanides, A. (2001) Monetary policy rules based on real-time data. American Economic Review 91 (4), 964–985.Google Scholar
Orphanides, A., Small, D., Wieland, V., and Wilcox, D. (2006) A quantitative exploration of the opportunistic approach to disinflation. Journal of Monetary Economics 53 (8), 1877–1893.Google Scholar
Orphanides, A. and Wilcox, D. (2002) The opportunistic approach to disinflation. International Finance 5 (1), 47–71.CrossRefGoogle Scholar
Primiceri, G. (2006) Why inflation rose and fell: Policymakers' beliefs and U.S. postwar stabilization policy. Quarterly Journal of Economics 121, 867–901.Google Scholar
Sargent, T., Williams, N., and Zha, T. (2006) Shocks and government beliefs: The rise and fall of American inflation. American Economic Review 96 (4), 1193–1224.CrossRefGoogle Scholar
Schorfheide, F. (2005) Learning and monetary policy shifts. Review of Economic Dynamics 8 (2), 392–419.Google Scholar
Sims, C. and Zha, T. (2006) Were there regime switches in U.S. monetary policy. American Economic Review 96 (1), 54–81.Google Scholar
Sims, C. A., Waggoner, D. F., and Zha, T. (2008) Methods for inference in large multiple-equation Markov-switching models. Journal of Econometrics 146 (2), 255–274.Google Scholar
Stock, J. H. and Watson, M. W. (2007) Why has inflation become harder to forecast. Journal of Money, Credit and Banking 39 (1), 3–33.CrossRefGoogle Scholar
Taylor, J. (1993) Discretion versus policy rules in practice. Carnegie-Rochester Conference Series on Public Policy 39, 195–214.CrossRefGoogle Scholar
Woodford, M. (2003a) Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton, NJ: Princeton University Press.Google Scholar
Woodford, M. (2003b) Optimal interest-rate smoothing. Review of Economic Studies 70, 861–886.CrossRefGoogle Scholar