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Monetary Policy and Macroeconomic Stability Revisited

February 28, 2020
Yasuo Hirose*1
Takushi Kurozumi*2
Willem Van Zandweghe*3


A large literature has established the view that the Fed's change from a passive to an active policy response to inflation led to U.S. macroeconomic stability after the Great Inflation of the 1970s. We revisit this view by estimating a generalized New Keynesian model using a full-information Bayesian method that allows for indeterminacy of equilibrium and adopts a sequential Monte Carlo algorithm. The estimated model empirically outperforms canonical New Keynesian models that confirm the literature's view. It also points to substantial uncertainty about whether the policy response to inflation was active or passive during the Great Inflation. More importantly, a more active policy response to inflation alone does not suffice for explaining the U.S. macroeconomic stability, unless it is accompanied by a change in either trend inflation or policy responses to the output gap and output growth. This extends the literature by emphasizing the importance of the changes in other aspects of monetary policy in addition to its response to inflation.

JEL Classification
C11, C52, C62, E31, E52

Monetary policy, Great Inflation, Indeterminacy, Trend inflation, Sequential Monte Carlo

The authors are grateful to Kosuke Aoki, Olivier Coibion, Taeyoung Doh, Ippei Fujiwara, Mark Gertler, Yuriy Gorodnichenko, Jonathan Heathcote, Edward Herbst, Alejandro Justiniano, Munechika Katayama, Christian Matthes, Sophocles Mavroeidis, Taisuke Nakata, Frank Schorfheide, Mototsugu Shintani, Sanjay Singh, Carl Walsh, Tsutomu Watanabe, Alexander Wolman, Raf Wouters, and participants at CEF 2017, CEF 2019, EEA-ESEM 2017, MMM 2018, SED 2018, SETA 2019, SWET 2018, 1st Keio-Waseda Macro Workshop, 13th Dynare Conference, 30th (EC)^2 Conference, and seminars at the Bank of Canada, the Bank of Japan, the Federal Reserve Bank of Kansas City, the Federal Reserve Board, the National Bank of Belgium, National Chengchi University, and University of Hawaii at Manoa for comments and discussions. The views expressed in this paper are those of the authors and do not necessarily reflect the official views of the Bank of Japan, the Federal Reserve Bank of Cleveland, or the Federal Reserve System.

  1. *1Faculty of Economics, Keio University
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  2. *2International Department, Bank of Japan
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  3. *3Research Department, Federal Reserve Bank of Cleveland
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