Monetary policy rules and macroeconomic stability: Evidence and some theory

TL;DR: In this article, the authors estimate a forward-looking monetary policy reaction function for the postwar United States economy, before and after Volcker's appointment as Fed Chairman in 1979, and compare some of the implications of the estimated rules for the equilibrium properties of ineation and output, using a simple macroeconomic model.

Abstract: We estimate a forward-looking monetary policy reaction function for the postwar United States economy, before and after Volcker’s appointment as Fed Chairman in 1979. Our results point to substantial differences in the estimated rule across periods. In particular, interest rate policy in the Volcker-Greenspan period appears to have been much more sensitive to changes in expected ineation than in the pre-Volcker period. We then compare some of the implications of the estimated rules for the equilibrium properties of ineation and output, using a simple macroeconomic model, and show that the Volcker-Greenspan rule is stabilizing.

Summary

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Figures

Figure I

Figure IV: The Real Interest Rate and Inflation

Figure III: Real Oil Price and Inflation

Figure VII: Impulse Responses to a Supply Shock

Figure II

Full text

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