Time‐Varying Response of Monetary Policy to Macroeconomic Conditions

Abstract

We reject the hypothesis that the Federal Reserve's response to the macroeconomy over the period of 1953‐1994 can be accurately represented with a fixed‐parameter discrete choice model. Thus, we model the Fed's time‐varying response with a nonlinear Kalman filter. The estimated time paths of the reaction function coefficients suggest that the Fed has responded countercyclically to movements in the price level except for the middle 1970s when it accommodated inflation. The Fed has generally responded countercyclically to unemployment and output during recessions. However, it has not maintained a countercyclical policy during nonrecessionary times until the 1980s.