Measuring Systematic Monetary Policy
Abstract
The 1970s and early 1980s witnessed two main approaches to the analysis of monetary
policy. The first is the early new classical approach of Lucas, based on the assumptions
of rational expectations and market clearing. The second is the atheoretical econometrics
of Sims' VAR program. Both have developed: the new classical approach has been enriched
through various accounts of price stickiness, cost of adjustment or alternative expectational
schemes; the original VAR program has developed into the structural VAR program. This
paper clarifies the relationship between these two programs. Based on work of Cochrane
(1998), it shows that the typical method of evaluating unanticipated, unsystematic
monetary policy is correct only if the conditions necessary for Lucas' policy-ineffectiveness
proposition hold, while recent methods for evaluating systematic monetary policy violate
Lucas' policy-noninvariance proposition ("the Lucas critique"). The paper shows how
to construct and estimate (using regime changes) a model in which some agents form
rational-expectations and others follow rules of thumb. In such a model, monetary
policy actions can be validly decomposed into systematic and unsystematic components
and valid counterfactual experiments on alternative systematic monetary-policy rules
can be evaluated.
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