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September/October 2001, 
Vol. 83, No. 5
Posted 2001-09-01

New Economy—New Policy Rules?

by Eric Schaling and James Bullard

The U.S. economy appears to have experienced a pronounced shift toward higher productivity over the last five years or so. The authors wish to understand the implications of such shifts for the structure of optimal monetary policy rules in simple dynamic economies. Accordingly, they begin with a standard economy in which a version of the Taylor rule constitutes the optimal monetary policy for a given inflation target and a given level of productivity. They augment this model with regime switching in productivity and calculate the optimal monetary policy rule in the altered environment. They find that, in the altered environment, a rule that incorporates leading indicators about regimes significantly outperforms the Taylor rule. They use this result to comment on the “new economy” events of the 1990s and the “stagflation” events of the 1970s from the perspective of their model.

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