Regime Switches , Agents ’ Beliefs , and Post - World War II U . S . Macroeconomic Dynamics Francesco Bianchi

The evolution of the U.S. economy over the last 55 years is examined through the lens of a micro-founded model that allows for changes in the behavior of the Federal Reserve and in the volatility of structural shocks. Agents are aware of the possibility of regime changes and their beliefs matter for the law of motion underlying the macroeconomy. Monetary policy is identified by repeated fluctuations between a Hawk and a Dove regime, with the latter prevailing in the ‘70s and during the recent crisis. To explore the role of agents’beliefs I introduce a new class of counterfactual simulations: beliefs counterfactuals. If, in the ‘70s, agents had anticipated the appointment of an extremely conservative Chairman, inflation would have been lower and the inflationoutput trade-off more favorable. The large drop in inflation and output at the end of 2008 would have been mitigated if agents had expected the Federal Reserve to be exceptionally active in the near future. ∗I would like to thank the editor Enrique Sentana and three anonymous referees for exceptionally thoughtful comments. I am deeply indebted to Chris Sims for his guidance and advice. I am also grateful to Mark Watson, Efrem Castelnuovo, Cosmin Ilut, Nobuhiro Kiyotaki, David Lucca, Esteban Rossi-Hansberg, Barbara Rossi, Tom Sargent, Tao Zha, and all seminar participants at Princeton University, the Board of Governors, the Federal Reserve Bank of Chicago, the New York Area Workshop on Monetary Policy, University of Pennsylvania, University of Virginia, Northwestern University, Duke University, UCLA, New York University, Philadelphia Fed, Penn State, CREI-Pompeu Fabra, University of Bern, NBER Summer Institute, Society for Economic Dynamics Annual Meeting, Richmond Fed, College of William and Mary, Johns Hopkins University, CEMFI, for useful suggestions and comments. Part of this paper was completed while the author was visiting the Board of Governors, whose hospitality is gratefully acknowledged. Correspondence: Duke University, 213 Social Sciences Building, Box 90097, Durham, NC 27708-0097. E-mail: [email protected].