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Monetary Policy and the Great Moderation in Macro Volatility

Monetary Policy and the Great Moderation in Macro Volatility. ECGA 7020 Special Topic Presentation Dan Maolusi Fall 2005 Fordham University. Evidence. GDP growth Std Dev decreases: Pre-1984: moving quarterly Std dev was about 4.7% Since 1984: moving quarterly Std dev fell to about 2.1%.

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Monetary Policy and the Great Moderation in Macro Volatility

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  1. Monetary Policy and the Great Moderation in Macro Volatility ECGA 7020 Special Topic Presentation Dan Maolusi Fall 2005 Fordham University

  2. Evidence GDP growth Std Dev decreases: • Pre-1984: moving quarterly Std dev was about 4.7% • Since 1984: moving quarterly Std dev fell to about 2.1%

  3. Std Dev of Quarterly U.S. GDP Growth Source: Anesto and Piger (2005) International Economic Trends; August.

  4. Causes and Explanations Three broad Explanations • Improved Macro Policy • Structural Change • Good Luck All three explanations have been explored in literature I focus on #1: better Macro Policy

  5. Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory • Clarida et. All (2000) argue improved monetary policy let to the “great moderation” • Estimate a Forward looking monetary policy reaction function for two eras: 60:1-79:2 and 79:3-96:4

  6. Standard Deviation of Inflation and output: pre and post Volcker

  7. Causes of declined Volatility • The decline in volatility appears substantial for each variable • The decline in volatility is more substantial when Volcker-Greenspan starts in 82:4, after the Volcker disinflation

  8. Taylor Rule for Fed Policy • where: the target rate for the nominal Federal Funds rate in period t • the percentage change in the price level between periods t and t+k • the target inflation • a measure of the average output gap between period t and t+q • the information set at the time the interest rate is set. • is an exogenous interest rate shock

  9. Taylor Rule Estimates • Table shows estimates of Fed response to expected inflation, , Column B and Fed response to GDP gap, , Column C • Standard errors are in parenthesis

  10. Column B: Volcker-Greenspan more responsive than pre-Volcker and therefore stabilizing since beta is greater than 1 • Column C: Volcker-Greenspan significantly greater than pre-Volcker, thus more responsive and stabilizing

  11. Differences in Policy Rules • Differ in terms of response to expected inflation • Pre-Volcker: short term rates allowed to fall with a rise in expected inflation • Fed would raise nominal rates but by less than the rise in expected inflation • Thus less pro-active policy in pre-Volcker

  12. Differences in Policy Rules • Volcker-Greenspan: real and nominal short term rates raised in response to higher expected inflation • Thus more proactive policy • Pre-Volcker less effective since it allows macroeconomic instability • Permits bursts in inflation and output • Less effective in mitigating shocks to economy

  13. Actual vs. Target interest rate

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