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Title: Monetary Magic? How the Fed Improved the Flexibility of the Economy

Author(s): Tamim Bayoumi and Silvia Sgherri

Publication Date: October 2004

Keyword(s): inflation dynamics, Kalman filter and monetary policy

Programme Area(s): International Macroeconomics

Abstract: Extending recent theoretical contributions on sources of inflation inertia, we argue that monetary policy uncertainty helps determine the sluggish adjustment of expectations to nominal disturbances. Estimating a model in which rational individuals learn over time about shifts in US monetary policy and the Phillips curve, we find strong evidence that this link exists. These results question the standard approach for evaluating monetary rules by assuming unchanged private sector responses, help clarify the role of monetary stability in reducing output variability in the US and elsewhere, and tell a subtle and dynamic story of the interaction between monetary policy and the supply-side of the economy.

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Bibliographic Reference

Bayoumi, T and Sgherri, S. 2004. 'Monetary Magic? How the Fed Improved the Flexibility of the Economy'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=4696