Endogenous Monetary Policy Regimes and the Great Moderation
Title: Endogenous Monetary Policy Regimes and the Great Moderation
Series/Number: EUI ECO; 2010/22
This paper contributes to the literature on the changing transmission mechanism of monetary policy by introducing a model whose parameter evolution explicitly depends on the conduct of monetary policy. We find that the model fits the data well, in particular when complemented with an estimated break around 1985 that could be associated with the re-gained credibility of the central bank. The responses of output and inflation to policy shocks change not only because of the break in 1985 but also according to the monetary policy stance: policy shocks have stronger negative e¤ects when policy is tight. There is also evidence in favour of large changes in the volatility of the output equation, but not of inflation. A set of counterfactual experiments indicate that good policy and good luck contributed to the great moderation, but neither of them can fully explain it. A more general variation in the model dynamics underlying the shock transmission mechanism is required.
Type of Access: openAccess