Monetary policy, inflation and unemployment: in defense of the Federal Reserve
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2013
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Groshenny, N.
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Macroeconomic Dynamics, 2013; 17(Special Issue 06):1311-1329
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Nicolas Groshenny
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To what extent did deviations from the Taylor rule between 2002 and 2006 help to promote price stability and maximum sustainable employment? To address that question, I estimate a New Keynesian model with unemployment and perform a counterfactual experiment where monetary policy strictly follows a Taylor rule over the period 2002:Q1–2006:Q4. I find that such a policy would have generated a sizeable increase in unemployment and resulted in an undesirably low rate of inflation. Around mid-2004, when the counterfactual deviates the most from the actual series, the model indicates that the probability of an unemployment rate greater than 8% would have been as high as 80%, whereas the probability of an inflation rate above 1% would have been close to zero.
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© Cambridge University Press 2012