How Optimal is US Monetary Policy?

Xiaoshan Chen, Tatiana Kirsanova and Campbell Leith

Working Papers from Business School - Economics, University of Glasgow

Abstract: Most of the literature estimating DSGE models for monetary policy analysis assume that policy follows a simple rule. In this paper we allow policy to be described by various forms of optimal policy - commitment, discretion and quasi-commitment. We find that, even after allowing for Markov switching in shock variances, the inflation target and/or rule parameters, the data preferred description of policy is that the US Fed operates under discretion with a marked increase in conservatism after the 1970s. Parameter estimates are similar to those obtained under simple rules, except that the degree of habits is significantly lower and the prevalence of cost-push shocks greater. Moreover, we find that the greatest welfare gains from the ‘Great Moderation’ arose from the reduction in the variances in shocks hitting the economy, rather than increased inflation aversion. However, much of the high inflation of the 1970s could have been avoided had policy makers been able to commit, even without adopting stronger anti-inflation objectives. More recently the Fed appears to have temporarily relaxed policy following the 1987 stock market crash, and has lost, without regaining, its post-Volcker conservatism following the bursting of the dot-com bubble in 2000.

Keywords: Bayesian Estimation; Interest Rate Rules; Optimal Monetary Policy; Great Mod- eration; Commitment; Discretion (search for similar items in EconPapers)
JEL-codes: C11 C51 C52 C54 E32 E58 (search for similar items in EconPapers)
Date: 2013-03
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

Downloads: (external link)
http://www.gla.ac.uk/media/media_274001_en.pdf (application/pdf)

Related works:
Journal Article: How optimal is US monetary policy? (2017)
Working Paper: How Optimal is US Monetary Policy? (2013)
Working Paper: How Optimal is US Monetary Policy? (2013)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:gla:glaewp:2013_08

Access Statistics for this paper

More papers in Working Papers from Business School - Economics, University of Glasgow Contact information at EDIRC.
Bibliographic data for series maintained by Business School Research Team ().