Bad luck, bad policy, and learning? A Markov-switching approach to understanding postwar U.S. macroeconomic dynamics

Gabriela Best () and Joonyoung Hur

European Economic Review, 2019, vol. 119, issue C, 55-78

Abstract: This paper evaluates the role of monetary policy in understanding the U.S. post-war macroeconomic fluctuations. We construct a medium-size DSGE model in which the central bank—through a real-time learning process—can make mistakes in estimating key elasticities between macroeconomic aggregates and the central banks objectives may change over time. The model also features time-varying volatilities of non-policy shocks. We find that misperceptions of the persistence of inflation and the slope of the Phillips curve could affect optimal monetary policy decision making. Therefore, their accurate prediction is key for achieving successful monetary policy outcomes. In addition, we argue that the monetary policy shift geared toward inflation stabilization in the late 1970s changed the composition of output making the marginal efficiency of investment shock—that proxies for the functioning of the financial sector—the most important contributor to the business cycle.

Keywords: Great inflation; Policy preferences; Policymakers’ beliefs; Learning; Markov-switching DSGE models (search for similar items in EconPapers)
JEL-codes: C11 D83 E31 E32 E44 E50 E52 E58 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:119:y:2019:i:c:p:55-78

DOI: 10.1016/j.euroecorev.2019.06.006

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