Recognition Program

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.

This paper is acknowledged by the Barcelona GSE Research Recognition Program