We estimate a forward-looking monetary policy reaction function for the postwar United States economy, before and after Volcker’s appointment as Fed Chairman in 1979. Our results point to substantial differences in the estimated rule across periods. In particular, interest rate policy in the Volcker-Greenspan period appears to have been much more sensitive to changes in expected in�ation than in the pre-Volcker period. We then compare some of the implications of the estimated rules for the equilibrium properties of in�ation and output, using a simple macroeconomic model, and show that the Volcker-Greenspan rule is stabilizing. I.

The views expressed in this paper are those of the authors and do not necessarily reflect those of the Bank of England. We have benefited greatly from the comments and suggestions of Bill

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This paper employs stochastic simulations of a small structural rational expectations model to investigate the consequences of the zero bound on nominal interest rates. We find that if the economy is subject to stochastic shocks similar in magnitude to those experienced in the U.S. over the 1980s and 1990s, the consequences of the zero bound are negligible for target inflation rates as low as 2 percent. However, the effects of the constraint are non-linear with respect to the inflation target and produce a quantitatively significant deterioration of the performance of the economy with targets between 0 and 1 percent. The variability of output increases significantly and that of inflation also rises somewhat. The stationary distribution of output is distorted with recessions becoming somewhat more frequent and longer lasting. Our model also uncovers that the asymmetry of the policy ineffectiveness induced by the zero bound generates a non-vertical long-run Phillips curve. Output falls increasingly short of potential with lower inflation targets. At zero average inflation, the output loss is in the order of 0.1 percentage points. We also investigate the consequences of the constraint on the analysis of optimal policy based on the inflation-output variability frontier. We demonstrate that in the presence of the zero bound, the variability frontier is distorted as the inflation target approaches zero. As a result comparisons of alternative policy rules that ignore the zero bound can be seriously misleading.

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A number of recent papers have developed dynamic macroeconomic models that incorporate rational expectations and optimizing foundations. While the theoretical motivation behind t hese models is sound, the dynamic implications of many of the specifications that assume rational expectations and optimizing behavior can be seriously at odds with t he data, for bo t h inflation and real-side variables. In a nutshell, the models imply that inflation or real spending "jump" in response to shocks, in contradiction to a host of empirical evidence that shows that both price and real-side variables exhibit gradual and "hump-shaped" responses to real and monetary shocks. For models that are intended for monetary policy analysis, these dynamic shortcomings should be considered quite serious. When monetary policy has only short-run effects on real variables, the inability to approximately capture the short-run responses of inflation or real variables to policy shocks makes a model unsuitable for pol...

This paper considers a prototypical monetary business cycle model for the U.S. economy, in which the equilibrium is undetermined if monetary policy is `passive'. In previous multivariate studies it has been common practice to restrict parameter estimates to values for which the equilibrium is unique. We show how the likelihood-based estimation of dynamic stochastic general equilibrium models can be extended to allow for indeterminacies and sunspot fluctuations. We construct

In this paper we estimate a small model of the euro area to be used as a laboratory for evaluating the performance of alternative monetary policy strategies. We start with the relationship between output and inflation and investigate the fit of the nominal wage contracting model due to Taylor (1980)and three different versions of the relative real wage contracting model proposed by Buiter and Jewitt (1981)and estimated by Fuhrer and Moore (1995a) for the United States. While Fuhrer and Moore reject the nominal contracting model in favor of the relative contracting model which induces more inflation persistence, we find that both models fit euro area data reasonably well. When considering France, Germany and Italy separately, however, we find that the nominal contracting model fits German data better, while the relative contracting model does quite well in countries which transitioned out of a high inflation regime such as France and Italy. We close the model by estimating an aggregate demand relationship and investigate the consequences of the different wage contracting specifications for the inflation-output variability tradeoff, when interest rates are set according to Taylor’s rule.

Schlagenhauf for extensive discussions. He has also benefited from discussions with Michelle Alexopoulos and Jonas Fisher. He thanks Victor Valdivia for his assistance in preparing example 5 and Christopher Gust for pointing out an error in an earlier draft. He is grateful for the

FEDERAL RESERVE BANK OF CLEVELANDWorking papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views stated herein are those of the authors and are not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. Working papers are now available electronically through the Cleveland Fed’s site on the World Wide Web: www.clev.frb.org. Working Paper 9910R