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

Efrem Castelnuovo, Luciano Greco and Davide Raggi

Macroeconomic Dynamics, 2014, vol. 18, issue 4, 920-942

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.

Date: 2014
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