Policy Regimes, Policy Shifts, and U.S. Business Cycles
- Author : Saroj Bhattarai, Jae Won Lee, and Woong Yong Park
- Journal : 2016, Review of Economics and Statistics / 98(5)
- Link : https://doi.org/10.1162/REST_a_00556
Abstract
Using an estimated DSGE model with monetary and fiscal policy interactions and allowing for equilibrium indeterminacy, we find that a passive monetary and passive fiscal policy regime prevailed in the pre-Volcker period. This gave rise to self-fulfilling beliefs and unconventional transmission mechanisms of policy shifts: unanticipated increases in interest rates increased inflation and output, while unanticipated increases in lump-sum taxes decreased inflation and output. We show that had the monetary policy regime of the post-Volcker era been in place pre-Volcker, inflation volatility would have been lower by 25% and the rise of inflation in the 1970s would not have occurred.