Revisiting the Great Moderation using the Method of Indirect Inference

Table 1: Competing Rival Models
Baseline framework
IS curve x t = E t x t+1 ( 1 )(~{ t
E t t+1 ) + v t
Phillips curve
t = E t t+1 +x t +u w t
Monetary policy versions
Optimal Timeless Rule
(model one)
original Taylor Rule
(model two)
& transformed equation
t = (x t
x t 1 ) + t
i A t = A t +0:5x t +0:5( A t
0:02) + 0:02 + t
~{ t = 1:5 t +0:125x t + 0 t
`IRS' Taylor Rule (2)
i
(model three)
A t = (1 )[ +
( ) + x
x t ] + i A t 1 + t
& transformed equation ~{ t = (1 )[
t + 0 xx t ] + ~{ t 1
+ 0 t
Since these models dier only in the monetary policies being implemented, by comparing
their capacity to t the data one should be able to tell which rule, when included
in a simple New Keynesian model, provides the best explanation of the facts and therefore
the most appropriate description of the underlying policy. We go on to investigate
this in what follows.
5 The Method of Indirect Inference
We evaluate the models' capacity in tting the data using the method of Indirect Inference
originally proposed in Minford, Theodoridis and Meenagh (2009) and subsequently with
a number of renements by Le et al. (2011) who evaluate the method using Monte Carlo
experiments. The approach employs an auxiliary model that is completely independent
of the theoretical one to produce a description of the data against which the performance
of the theory is evaluated indirectly. Such a description can be summarised either by the
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