5 - Policy and Aggregate Variability
Published online by Cambridge University Press: 10 August 2009
Summary
This chapter solves the theoretical model in Chapter 4 and demonstrates the effects of the Taylor rule (adherence to the Taylor principle) on output and inflation stability. Our dynamic equilibrium model uses the interaction of policy (transmitted via interest rate movements) with temporary information coordination rigidities. A particular focus is on trade-offs between inflation and output volatility and on whether IOCS can exist. We also determine the possible trade-offs posed by various policy targets (hereafter termed crossover effects).
We evaluate the model outlined in Chapter 4 by conventional means. As McCallum (2001b) notes, standard evaluation practice occurs along the following lines:
The researcher specifies a quantitative macroeconomic model that is intended to be structural (invariant to policy changes) and consistent with both theory and data. Then, by stochastic simulation or analytical means, he [the researcher] determines how crucial variables (such as inflation and the output gap) behave on average under various alternative policy rules. Usually, rational expectations (RE) is assumed in both stages. Evaluation of the different outcomes can be accomplished by means of an optimal control exercise, or left to the judgment (i.e., loss function) of the implied policymaker (p. 258).
Feasibility
In this section we first determine whether policymakers can reach their desired levels (targets) in inflation and output. This step is basic for any further inquiry.
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- Information
- The Role of Policymakers in Business Cycle Fluctuations , pp. 136 - 152Publisher: Cambridge University PressPrint publication year: 2006