Drifts and Volatilities: Monetary Policies and Outcomes in the Post WWII U.S.

Timothy Cogley and Thomas J. Sargent
Working Paper 2003-25
October 2003

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For a VAR with drifting coefficients and stochastic volatilities, the authors present posterior densities for several objects that are of interest for designing and evaluating monetary policy. These include measures of inflation persistence, the natural rate of unemployment, a core rate of inflation, and “activism coefficients” for monetary policy rules. Their posteriors imply substantial variation of all of these objects for post WWII U.S. data. After adjusting for changes in volatility, persistence of inflation increases during the 1970s then falls in the 1980s and 1990s. Innovation variances change systematically, being substantially larger in the late 1970s than during other times. Measures of uncertainty about core inflation and the degree of persistence covary positively. The authors use their posterior distributions to evaluate the power of several tests that have been used to test the null of time-invariance of autoregressive coefficients of VARs against the alternative of time-varying coefficients. Except for one test, they find that those tests have low power against the form of time variation captured by our model. That one test also rejects time invariance in the data.

JEL classification: C11, E31, E5

Keywords: Bayesian analysis, inflation, monetary policy

For comments and suggestions, the authors are grateful to Jean Boivin, Marco Del Negro, Mark Gertler, Sergei Morozov, Simon Potter, Christopher Sims, Mark Watson, and Tao Zha. This paper was presented at the Monetary Policy and Learning Conference sponsored by the Federal Reserve Bank of Atlanta in March 2003. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Tim Cogley, Department of Economics, University of California, Davis, One Shields Avenue, Davis, California 95616, 530-752-1581, twcogley@ucdavis.edu or Tom Sargent, Department of Economics, New York University, 269 Mercer Street, 8th Floor, New York, New York 10003, 212-998-3548, thomas.sargent@nyu.edu.