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The Fed and the New Economy

The Fed and the New Economy †By LAURENCE BALL AND ROBERT R. TCHAIDZE* late 1990’s. And if it did deviate, then why? As Milton Friedman (2001 p. 105) has asked, “[D]oes Alan Greenspan have an insight into movements in the economy and the shocks that other people don’t have?” We investigate these issues by estimating Taylor rules for two parts of Greenspan’s tenure at the Fed, the “old economy” period from 1987 through 1995 and the “new economy” period from 1996 through 2000. We first consider a simple version of the rule in which the federal funds rate depends on the inflation rate and the unemployment rate. This rule explains the Fed’s behavior well during the old-economy period, but it breaks down after 1995. We then consider a Taylor rule in which the raw unemployment rate is replaced by the deviation of unemployment from the NAIRU (the non-accelerating inflation rate of unemployment). With this specification, the Fed’s behavior appears stable across the old- and new-economy periods. Its failure to raise interest rates in response to falling unemployment is explained by a decrease in the NAIRU in the late 1990’s. I. A Simple Taylor Rule Starting with John Taylor (1993), a large literature argues http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Review American Economic Association

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Publisher
American Economic Association
Copyright
Copyright © 2002 by the American Economic Association
Subject
Monetary-Policy Rules in Practice
ISSN
0002-8282
DOI
10.1257/000282802320189096
Publisher site
See Article on Publisher Site

Abstract

†By LAURENCE BALL AND ROBERT R. TCHAIDZE* late 1990’s. And if it did deviate, then why? As Milton Friedman (2001 p. 105) has asked, “[D]oes Alan Greenspan have an insight into movements in the economy and the shocks that other people don’t have?” We investigate these issues by estimating Taylor rules for two parts of Greenspan’s tenure at the Fed, the “old economy” period from 1987 through 1995 and the “new economy” period from 1996 through 2000. We first consider a simple version of the rule in which the federal funds rate depends on the inflation rate and the unemployment rate. This rule explains the Fed’s behavior well during the old-economy period, but it breaks down after 1995. We then consider a Taylor rule in which the raw unemployment rate is replaced by the deviation of unemployment from the NAIRU (the non-accelerating inflation rate of unemployment). With this specification, the Fed’s behavior appears stable across the old- and new-economy periods. Its failure to raise interest rates in response to falling unemployment is explained by a decrease in the NAIRU in the late 1990’s. I. A Simple Taylor Rule Starting with John Taylor (1993), a large literature argues

Journal

American Economic ReviewAmerican Economic Association

Published: May 1, 2002

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