Monetary policy, target inflation and the great moderation: an empirical investigation
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2017
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Haque, Q.G.
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Qazi Haque
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This paper compares the empirical fit of a Taylor rule featuring constant versus time-varying inflation target by estimating a Generalized New Keyne- sian model under positive trend inflation while allowing for indeterminacy. The estimation is conducted over two di¤erent periods covering the Great Inflation and the Great Moderation. We find that the rule embedding time variation in target inflation turns out to be empirically superior and determinacy prevails in both sample periods. Counterfactual simulations point toward both 'good policy' and 'good luck' as drivers of the Great Moderation. We find that bet- ter monetary policy, both in terms of a more active response to inflation gap and a more anchored inflation target, has resulted in the decline in inflation gap volatility and predictability. In contrast, the reduction in output growth variability is mainly explained by reduced volatility of technology shocks.
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