Monetary Policy and the Stability of Macroeconomic Relationships

Estimates of the effect of different international monetary regimes on the parameters of the Phillips curve, the Keynesian consumption function, and other reduced-form macroeconomic relationships are given. The estimates provide a quantitative assessment of the importance of the Lucas critique for such regime shifts. The estimates are calculated by stochastically simulating an estimated multicountry economic model with rational expectations under a fixed exchange rate regime and a flexible exchange rate regime. In both regimes interest rates are the primary instrument of monetary policy. Noticeable shifts occur in most of the macroeconomic relationships, especially in the consumption function and the Phillips curve, and these shifts have simple economic interpretations based on the changes in the variance and the serial correlation of income and prices in the two regimes. However, in most cases the shifts are not large quantitatively. At least, as implemented here, this type of regime shift does not seem to generate much instability in the conventional macroeconomic relationships. Several possible reasons for this finding are discussed in the paper.