Working Paper: NBER ID: w10764
Authors: Thomas Sargent; Noah Williams; Tao Zha
Abstract: We use a Bayesian Markov Chain Monte Carlo algorithm to estimate a model that allows temporary gaps between a true expectational Phillips curve and the monetary authority's approximating non-expectational Phillips curve. A dynamic programming problem implies that the monetary authority's inflation target evolves as its estimated Phillips curve moves. Our estimates attribute the rise and fall of post WWII inflation in the US to an intricate interaction between the monetary authority's beliefs and economic shocks. Shocks in the 1970s altered the monetary authority's estimates and made it misperceive the tradeoff between inflation and unemployment. That caused a sharp rise in inflation in the 1970s. Our estimates say that policymakers updated their beliefs continuously. By the 1980s, their beliefs about the Phillips curve had changed enough to account for Volcker's conquest of US inflation in the early 1980s.
Keywords: inflation; monetary policy; Phillips curve; Bayesian estimation; learning
JEL Codes: E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Shocks in the 1970s (E65) | Misperception of inflation-unemployment tradeoff (E31) |
| Misperception of inflation-unemployment tradeoff (E31) | Rise in inflation (E31) |
| Monetary authority's beliefs evolved (E49) | Reduction of inflation by Volcker (E31) |
| Shocks in the 1970s (E65) | Rise in inflation (E31) |