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Abstract:
An equilibrium model is used to assess the quantitative importance of monetary policy for the post-1984 decline in U.S. inflation and output volatility. The principal finding is that monetary policy played a substantial role in reducing inflation volatility, but a small role in reducing real output volatility. The model attributes much of the decline in real output volatility to smaller TFP shocks. We also investigate the pattern of output and inflation volatility under an optimal monetary policy counterfactual. We find that real output volatility would have been somewhat lower, and inflation volatility substantially lower, had monetary policy been set optimally.
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Keywords
business cycles, optimal monetary policy
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