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American Economic Review: Vol. 101 No. 1 (February 2011)

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Monetary Policy, Trend Inflation, and the Great Moderation: An Alternative Interpretation

Article Citation

Coibion, Olivier, and Yuriy Gorodnichenko. 2011. "Monetary Policy, Trend Inflation, and the Great Moderation: An Alternative Interpretation." American Economic Review, 101(1): 341-70.

DOI: 10.1257/aer.101.1.341

Abstract

With positive trend inflation, the Taylor principle does not guarantee a determinate equilibrium. We provide new theoretical results on determinacy in New Keynesian models with positive trend inflation and new empirical findings on the Federal Reserve's reaction function before and after the Volcker disinflation to find that, (i) while the Fed likely satisfied the Taylor principle before Volcker, the US economy was still subject to self-fulfilling fluctuations in the 1970s, (ii) the US economy switched to determinacy during the Volcker disinflation, and (iii) the switch reflected changes in the Fed's response to macroeconomic variables and the decline in trend inflation. (JEL E12, E23, E31, E32, E52)

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Authors

Coibion, Olivier (College of William and Mary)
Gorodnichenko, Yuriy (U CA, Berkeley)

JEL Classifications

E12: General Aggregative Models: Keynes; Keynesian; Post-Keynesian
E23: Macroeconomics: Production
E31: Price Level; Inflation; Deflation
E32: Business Fluctuations; Cycles
E52: Monetary Policy


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