The conquest of US inflation: Learning and robustness to model uncertainty

Timothy Cogley, Thomas J. Sargent

    Research output: Contribution to journalArticlepeer-review

    Abstract

    Previous studies have interpreted the rise and fall of US inflation after World War II in terms of the Fed's changing views about the natural rate hypothesis but have left an important question unanswered. Why was the Fed so slow to implement the low-inflation policy recommended by a natural rate model even after economists had developed statistical evidence strongly in its favor? Our answer features model uncertainty. Each period a central bank sets the systematic part of the inflation rate in light of updated probabilities that it assigns to three competing models of the Phillips curve. Cautious behavior induced by model uncertainty can explain why the central bank presided over the inflation of the 1970s even after the data had convinced it to place much the highest probability on the natural rate model.

    Original languageEnglish (US)
    Pages (from-to)528-563
    Number of pages36
    JournalReview of Economic Dynamics
    Volume8
    Issue number2 SPEC. ISS.
    DOIs
    StatePublished - Apr 2005

    Keywords

    • Anticipated utility
    • Bayes' law
    • Natural unemployement rate
    • Phillips curve
    • Robustness

    ASJC Scopus subject areas

    • Economics and Econometrics

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