THE INSTABILITY IN THE MONETARY POLICY REACTION FUNCTION AND THE ESTIMATION OF MONETARY POLICY SHOCKS

We extend Romer and Romer's (2004) analysis of the estimation and the effects of monetary policy shocks by controlling for (1) changes in the monetary policy reaction function and (2) changes in the response of output and prices over time with an extended data set. The results suggest that the post 1979 responses of output and prices to a monetary policy shock are significantly different from what has been reported for the whole sample: While output and prices respond significantly and negatively if their response is estimated for the whole sample period (1969–2005), the response of output is insignificant for the period of 1979–2005, and the response of prices is much weaker. The analysis of the changes in the monetary policy conducted over time allows us to partly attribute the diminished price and output responses to a successful monetary policy which led to a less volatile economy during the great moderation. (JEL E52, E32, C50)