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Do We Really Know that U.S. Monetary Policy was Destabilizing in the 1970s?

Qazi Haque (), Nicolas Groshenny and Mark Weder ()

No 2018-03, School of Economics Working Papers from University of Adelaide, School of Economics

Abstract: In this paper we examine whether or not monetary policy was a source of instability during the Great Inflation. We focus on a number of attributes that we see relevant for any analysis of the 1970s: cost-push or oil price shocks, positive trend inflation as well as real wage rigidity. We turn our artificial sticky-price economy into a Bayesian model and find that the U.S. economy during the 1970s is best characterized by a high degree of real wage rigidity. Oil price shocks thus created a trade-off between inflation and output-gap stabilization. Faced with this dilemma, the Federal Reserve reacted aggressively to inflation but hardly at all to the output gap, thereby inducing stability, i.e. determinacy.

Keywords: Monetary policy; Great Inflation; Cost-push shocks; Trend inflation; Sequential Monte Carlo algorithm (search for similar items in EconPapers)
JEL-codes: E32 E52 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-his, nep-hpe, nep-knm, nep-mac and nep-mon
Date: 2018-05
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