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Monetary Policy, Inflation Target and the Great Moderation: An Empirical Investigation

Qazi Haque ()

No 2017-13, School of Economics Working Papers from University of Adelaide, School of Economics

Abstract: This paper compares the empirical fit of a Taylor rule featuring constant versus time-varying inflation target by estimating a Generalized New Keynesian model under positive trend inflation while allowing for indeterminacy. The estimation is conducted over two different periods covering the Great Inflation and the Great Moderation. We find that the rule embedding time variation in target inflation turns out to be empirically superior and determinacy prevails in both sample periods. Counterfactual simulations point toward both `good policy' and `good luck' as drivers of the Great Moderation. We find that better monetary policy, both in terms of a more active response to inflation gap and a more anchored inflation target, has resulted in the decline in inflation gap volatility and predictability. In contrast, the reduction in output growth variability is mainly explained by reduced volatility of technology shocks.

Keywords: Monetary policy; Great Inflation; Great Moderation; Equilibrium Indeterminacy; Generalized New Keynesian Phillips curve; Taylor rules; Time-varying inflation target; Good policy; Good luck; Sequential Monte Carlo (search for similar items in EconPapers)
JEL-codes: C11 C52 C62 E31 E32 E52 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2017-11
Note: Revision
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