DP4675 Deconstructing the Art of Central Banking

Author(s): Tamim Bayoumi, Silvia Sgherri
Publication Date: October 2004
Keyword(s): inflation, monetary policy, rational expectation models
JEL(s): E31, E32
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4675

This Paper proposes a markedly different transmission from monetary policy to the macroeconomy, focusing on how policy changes nominal inertia in the Phillips curve. Using recent theoretical developments, we examine the properties of a small, estimated US monetary model distinguishing four monetary regimes since the late 1950s. We find that changes in monetary policy are linked to shifts in nominal inertia, and that these improvements in supply-side flexibility are indeed the main channel through which monetary policy lowers the volatility of inflation and, even more importantly, output.