Department of Economics and Business Economics

Do we really know that U.S. monetary policy was destabilizing in the 1970s?

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  • Qazi Haque, University of Western Australia, CAMA
  • ,
  • Nicolas Groshenny, University of Adelaide, CAMA
  • ,
  • Mark Weder

The paper re-examines whether the Federal Reserve's monetary policy was a source of instability during the Great Inflation by estimating a sticky-price model with positive trend inflation, commodity price shocks and sluggish real wages. Our estimation provides empirical evidence for substantial wage rigidity and finds that the Federal Reserve responded aggressively to inflation but negligibly to the output gap. In the presence of non-trivial real imperfections and well-identified commodity price-shocks, U.S. data prefers a determinate version of the New Keynesian model: monetary policy-induced indeterminacy and sunspots were not causes of macroeconomic instability during the pre-Volcker era. However, had the Federal Reserve in the Seventies followed the policy rule of the Volcker-Greenspan-Bernanke period, inflation volatility would have been lower by one third.

Original languageEnglish
Article number103615
JournalEuropean Economic Review
Number of pages24
Publication statusPublished - Jan 2021

Bibliographical note

Funding Information:
The authors particularly thank the Editor Florin Bilbiie, an Associate Editor and two anonymous referees for their comments which have greatly improved our manuscript. We are also grateful to Gianni Amisano, Martin Møller Andreasen, Guido Ascari, Drago Bergholt, Hilde Bjørnland, Michael Burda, Giovanni Caggiano, Fabio Canova, Efrem Castelnuovo, Ferre De Graeve, Chris Edmond, Yunjong Eo, Andrea Ferrero, Ippei Fujiwara, Francesco Furlanetto, Pedro Gomis-Porqueras, Punnoose Jacob, Frederic Karame, Benjamin Keen, Mariano Kulish, François Langot, Thomas Lubik, James Morley, Adrian Pagan, Giovanni Pellegrino, Luca Pensieroso, Bo Sandemann Rasmussen, Petr Sedláček, Mathias Trabandt, Harald Uhlig, Elliott Weder and Raf Wouters for helpful discussions on various drafts of this paper. This work was supported with supercomputing resources provided by the Phoenix HPC service at The University of Adelaide. Weder acknowledges research support from the Australian Research Council , under the grant DP140102869 and would also like to thank the Bank of Finland and Keio University for their hospitality. Haque acknowledges generous support from the Australian Research Council, under the grant DP170100697 , and would like to thank the University of Oxford for their hospitality.

Publisher Copyright:
© 2020 Elsevier B.V.

Copyright 2020 Elsevier B.V., All rights reserved.

    Research areas

  • Cost-push shocks, Great inflation, Indeterminacy, Monetary policy, Trend inflation

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