• "… investigates the potential causes of the poor economic performance of the 70s and early 80s and to what extent monetary policy played an important role in these high unemployment and inflation episodes."

• Two are the main characteristics required to address the issue:

  1. Time varying parameters (TVP): in order to measure policy changes and implied shifts in the private sector behavior
  2. A multiple equation model (VAR): in order to understand how changes in policy have affected the rest of the economy.

\[ \begin{align} &y_t& &=& &c_t + \beta_{ij_{t}} y_{t-k} + \underbrace{A_{t}^{-1} \Sigma_t \epsilon_t}_{u_t} \\ &c_{i_{t}}& &=& &c_{i_{t-1}} + \gamma_{t} \\ &\beta_{ij_{t}}& &=& &\beta_{ij_{t-1}} + \nu_{t} \\ &\alpha_{ij_{t}}& &=& &\alpha_{ij_{t-1}} + \zeta_{t} \\ &log (\sigma_{ij_{t}})& &=& &log (\sigma_{ij_{t-1}}) + \eta_{t} \end{align} \]

\(\epsilon_{t}\): additive shock

\(\zeta_t\): shock to \(i_t\) in \(\pi_t\) and \(u_t\)

\(\nu_t\): shock of \(i_t\) in \(i_{t-k}\), \(\pi_{t-k}\) and \(u_{t-k}\)

• Three variables: inflation (\(\pi\)), unemployment (\(u\)) and interest rate (\(i\))

• The sample runs from 1953:I to 2001:III.

• Two lags are used for the estimation.

• Priors are calibreated using the first 10 years of data.

• Both systematic and non-systematic monetary policy have changed during the last forty years:

  • systematic monetary policy \(\Uparrow\)
  • non-systematic monetary policy \(\Downarrow\)

• The role played by exogenous non-policy shocks seems more important than interest rate policy in explaining the high inflation and unemployment episodes in recent US economic history.

  • Controversial (Lucas critique, 1982)