Hostname: page-component-cd9895bd7-gbm5v Total loading time: 0 Render date: 2024-12-19T03:15:08.120Z Has data issue: false hasContentIssue false
  • English
  • Français

POLICY SWITCH AND THE GREAT MODERATION: THE ROLE OF EQUILIBRIUM SELECTION

Published online by Cambridge University Press:  30 December 2011

Efrem Castelnuovo
Efrem Castelnuovo*
Affiliation:
University of Padua and Bank of Finland
*
Address correspondence to: Efrem Castelnuovo, Department of Economics, University of Padua, Via del Santo 33, I-35123 Paduva (PD), Italy; e-mail: [email protected].
Get access Rights & Permissions [Opens in a new window]

Abstract

“Good policy” and “good luck” have been identified as two of the possible drivers of the “Great Moderation,” but their relative importance is still widely debated. This paper investigates the role played by equilibrium selection under indeterminacy in the assessment of their relative merits. We contrast the outcomes of counterfactual simulations conditional on the “continuity” selection strategy–largely exploited by the literature–with those obtained with a novel “sign restriction” based strategy. Our results suggest that conclusions achieved under “continuity” are not necessarily robust to the selection of different–still economically sensible–equilibria. According to our simulations, the switch to a hawkish systematic monetary policy may very well induce an increase in output volatility. Hence, our sign restriction–selection strategy “resurrects” the inflation–output policy tradeoff.

Keywords

Great ModerationIndeterminacyGood PolicyGood LuckEquilibrium Selection
Type
Articles
Information
Macroeconomic Dynamics , Volume 16 , Issue 3 , June 2012 , pp. 449 - 471
Copyright
Copyright © Cambridge University Press 2011

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

Belaygorod, A. and Dueker, M. (2007) Indeterminacy, change points and the price puzzle, Journal of Economic Dynamics and Control 33 (3), 624–648.Google Scholar
Benati, L. (2008) Are “Intrinsic Inflation Persistence” Models Structural in the Sense of Lucas (1976)? Mimeo, European Central Bank.CrossRefGoogle Scholar
Benati, L. and Surico, P. (2008) Evolving U.S. monetary policy and the decline of inflation predictability. Journal of the European Economic Association 6 (2–3), 634–646.CrossRefGoogle Scholar
Benati, L. and Surico, P. (2009) VAR analysis and the Great Moderation. American Economic Review 99 (4), 1636–1652.Google Scholar
Bianchi, F. (2009) Regime Switches, Agents' Beliefs, and Post-World War II U.S. Macroeconomic Dynamics. Mimeo, Princeton University.CrossRefGoogle Scholar
Blanchard, O. and Simon, J. (2001) The long and large decline in U.S. output volatility. Brookings Papers on Economic Activity 1, 135–174.CrossRefGoogle Scholar
Boivin, J. and Giannoni, M.P. (2006) Has monetary policy become more effective? Review of Economics and Statistics 88 (3), 445–462.CrossRefGoogle Scholar
Campbell, J.R. and Hercowitz, Z. (2006) The Role of Collateralized Households Debt in Macroeconomic Stabilization. Mimeo, Federal Reserve Bank of Chicago and Tel Aviv University.Google Scholar
Canova, F. and Gambetti, L. (in press) Do inflation expectations matter? The Great Moderation revisited. American Economic Journal: Macroeconomics. Forthcoming.Google Scholar
Canova, F. and Gambetti, L. (2009) Structural changes in the US economy: Is there a role for monetary policy? Journal of Economic Dynamics and Control 33 (2), 477–490.Google Scholar
Canova, F., Gambetti, L., and Pappa, E. (2008) The structural dynamics of the U.S. output and inflation: What explains the changes? Journal of Money, Credit, and Banking 40 (2–3), 369–388.Google Scholar
Canova, F. and Pina, J. (1999) Monetary Policy Misspecification in VAR Models. CEPR Discussion Paper 2332.Google Scholar
Castelnuovo, E. (2006) Assessing Different Drivers of the Great Moderation in the U.S. Working paper 25, University of Padua.Google Scholar
Castelnuovo, E., Greco, L., and Raggi, D. (2008) Estimating Regime-Switching Taylor Rules with Trend Inflation. Bank of Finland research discussion paper 20.CrossRefGoogle Scholar
Castelnuovo, E. and Nisticò, S. (2010) Stock market conditions and monetary policy in a DSGE model for the U.S. Journal of Economic Dynamics and Control 34 (9), 1700–1731.Google Scholar
Castelnuovo, E. and Surico, P. (in press) Monetary policy, inflation expectations, and the price puzzle. The Economic Journal.Google Scholar
Christiano, L.J.Eichenbaum, M., and Evans, C.L. (2005) Nominal rigidities and the dynamic effect of a shock to monetary policy. Journal of Political Economy 113 (1), 1–45.Google Scholar
Ciccarelli, M. and Mojon, B. (in press) Global inflation. Review of Economics and Statistics.Google Scholar
Clarida, R., Galí, J., and Gertler, M. (2000) Monetary policy rules and macroeconomic stability: Evidence and some theory. Quarterly Journal of Economics 115 (1), 147–180.CrossRefGoogle Scholar
Cogley, T. and Sargent, T. J. (2005) Drift and volatilities: Monetary policies and outcomes in the post WWII US. Review of Economic Dynamics 8 (2), 262–302.CrossRefGoogle Scholar
Dynan, K.E., Elmendorf, D.W., and Sichel, D.E. (2006) Can financial innovation help to explain the reduced volatility of economic activity? Journal of Monetary Economics 53 (1), 123–150.CrossRefGoogle Scholar
Fuhrer, J.C. and Rudebusch, G.D. (2004) Estimating the Euler equation for output. Journal of Monetary Economics 51 (6), 1133–1153.CrossRefGoogle Scholar
Giannone, D., Lenza, M., and Reichlin, L. (2008) Explaining the great Moderation: It is not the shocks. Journal of the European Economic Association 6 (2–3), 621–633.CrossRefGoogle Scholar
Herrera, A.M. and Pesavento, E. (2005) The decline of U.S. output volatility: Structural changes in inventory investment. Journal of Business and Economic Statistics 23 (4), 462–472.CrossRefGoogle Scholar
Judd, John and Rudebusch, Glenn D. (1998) Taylor's rule and the Fed: 1970–1997. Federal Reserve Bank of San Francisco Economic Review 3, 1–16.Google Scholar
Justiniano, A. and Primiceri, G. (2008a) Potential and Natural Output. Mimeo, Federal Reserve Bank of Chicago and Northwestern University.Google Scholar
Justiniano, A. and Primiceri, G. (2008b) The time varying volatility of macroeconomic fluctuations. American Economic Review 98 (3), 604–641.Google Scholar
Kahn, J.A., McConnell, M., and Perez-Quiros, G. (2002) On the causes of the increased stability of the U.S. economy. Federal Reserve Bank of New York Economic Policy Review 8 (1).Google Scholar
Kim, C. and Nelson, C. (1999) Has the U.S. economy become more stable? A Bayesian approach based on a Markov-switching model of the business cycle. Review of Economics and Statistics 81 (4), 608–616.Google Scholar
Kim, C., Nelson, C., and Piger, J. (2004) The less volatile U.S. economy: A Bayesian investigation of timing, breadth, and potential explanations. Journal of Business and Economic Statistics 22 (1), 80–93.CrossRefGoogle Scholar
Krueger, A. (2003) General Discussion: Has the Business Cycle Changed? Evidence and Explanations. In Federal Reserve Bank of Kansas City, Proceedings of the Symposium on “Monetary Policy and Uncertainty,” Jackson Hole, Wyoming, August 28–30.Google Scholar
Lubik, T.A. and Marzo, M. (2007) An inventory of simple monetary policy rules in a new Keynesian macroeconomic model. International Review of Economics and Finance 16 (1), 15–36.CrossRefGoogle Scholar
Lubik, T.A. and Schorfheide, F. (2003) Computing sunspot equilibria in linear rational expectations models. Journal of Economic Dynamics and Control 28 (2), 273–285.Google Scholar
Lubik, T.A. and Schorfheide, F. (2004) Testing for indeterminacy: An application to US monetary policy. American Economic Review 94 (1), 190–217.CrossRefGoogle Scholar
Lubik, T.A. and Surico, P. (in press) The Lucas critique and the stability of empirical models. Journal of Applied Econometrics.Google Scholar
Maccini, L.J. and Pagan, A. (2003) Exploring the Role of Inventories in the Business Cycle. Mimeo, Johns Hopkins University and Australian National University.Google Scholar
Mavroeidis, S. (in press) Monetary policy rules and macroeconomic stability: Some new evidence. American Economic Review.Google Scholar
McCallum, B. (1983) On non-uniqueness in rational expectations models: An attempt at perspective. Journal of Monetary Economics 11, 139–168.Google Scholar
McConnell, M. and Perez-Quiros, G. (2000) Output fluctuations in the United States: What has changed since the early 1980's? American Economic Review 90 (5), 1464–1476.CrossRefGoogle Scholar
Mumtaz, H. and Surico, P. (2008) Evolving International Inflation Dynamics: Evidence from a Time-Varying Dynamic Factor Model. CEPR discussion paper 6767.Google Scholar
Primiceri, G. (2005) Time varying structural vector autoregressions and monetary policy. Review of Economic Studies 72, 821–852.Google Scholar
Sims, C.A. (2001) Solving linear rational expectations models. Journal of Computational Economics 20, 1–20.Google Scholar
Sims, C.A. and Zha, T. (2006) Were there regime switches in US monetary policy? American Economic Review 96 (1), 54–80.Google Scholar
Smets, F. and Wouters, R. (2007) Shocks and frictions in US business cycle: A Bayesian DSGE approach. American Economic Review 97 (3), 586–606.CrossRefGoogle Scholar
Stock, J.H. and Watson, M.W. (2002) Has the business cycle changed and why? In Gertler, M. and Rogoff, K. (eds.), NBER Macroeconomic Annual. Cambridge, MA: MIT Press.Google Scholar
Stock, J.H. and Watson, M.W. (2003) Has the business cycle changed? Evidence and explanations. In Federal Reserve Bank of Kansas City, Proceedings of the Symposium on “Monetary Policy and Uncertainty,” Jackson Hole, Wyoming, August 28–30.Google Scholar
Surico, P. (2008) Monetary Policy Shifts and Inflation Dynamics. Working paper 338, Bank of England.Google Scholar
Taylor, J.B. (1993) Discretion vs. policy rules in practice. Carnegie–Rochester Conference Series on Public Policy 39, 195–214.CrossRefGoogle Scholar
Uhlig, H. (2005) What are the different effects of monetary policy on output? Results from an agnostic identification procedure. Journal of Monetary Economics 52 (2), 381–419.CrossRefGoogle Scholar
Woodford, M. (2003) Interest and Prices: Foundation of a Theory of Monetary Policy. Princeton, NJ: Princeton University Press.Google Scholar