Working Paper

New economy - new policy rules?

Abstract: The U.S. economy appears to have experienced a pronounced shift toward higher productivity over the last five years or so. We wish to understand the implications of such shifts for the structure of optimal monetary policy rules in simple dynamic economies. Accordingly, we begin with a standard economy in which a version of the Taylor rule constitutes the optimal monetary policy for a given inflation target and a given level of productivity. We augment this model with regime switching in productivity, and calculate the optimal monetary policy rule in the altered environment. We find that in the altered environment, a rule that incorporates leading indicators about regimes significantly outperforms the Taylor rule. We use this result to comment on the \"new economy\" events of the 1990s and the \"stagflation\" events of the 1970s form the perspective of our model.

Keywords: Monetary policy; Inflation (Finance); economic conditions - United States;

Status: Published in Federal Reserve Bank of St. Louis Review, September/October 2001, 83(5), pp. 57-66

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2000

Number: 2000-019