Authors: Davide Debortoli and Aeimit K. Lakdawala

American Economic Journal: Macroeconomics, Vol. 8, No 3, 42-76, July, 2016

Using a Markov-switching Bayesian likelihood approach, the paper proposes a new measure of the degree of credibility of the Federal Reserve. We estimate a mediumscale macroeconomic model, where the central bank has access to a commitment technology, but where a regime-switching process governs occasional re-optimizations of announced plans. The framework nests the commonly used discretion and commitment cases, while allowing for a continuum of intermediate cases. Our estimates reject both full-commitment and discretion. We instead identify occasional re-optimization episodes that are consistent with changes in Federal Reserve policymakers and operating procedures. Finally, through counterfactual analysis we assess the role of credibility over the past four decades.