Christopher A. Sims and Tao Zha
Working Paper 2004-14
June 2004

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A multivariate model, identifying monetary policy and allowing for simultaneity and regime switching in coefficients and variances, is confronted with U.S. data since 1959. The best fit is with a model that allows time variation in structural disturbance variances only. Among models that also allow for changes in equation coefficients, the best fit is for a model that allows coefficients to change only in the monetary policy rule. That model allows switching among three main regimes and one rarely and briefly occurring regime. The three main regimes correspond roughly to periods when most observers believe that monetary policy actually differed, and the differences in policy behavior are substantively interesting, though statistically ill determined. The estimates imply monetary targeting was central in the early ’80s but was also important sporadically in the ’70s. The changes in regime were essential neither to the rise in inflation in the ’70s nor to its decline in the ’80s.

JEL classification: E52, E47, C53

Key words: counterfactuals, Lucas critique, policy rule, monetary targeting, simultaneity, volatility, model comparison

The authors are indebted to Dan Waggoner for many helpful discussions as well as for his invaluable help on C programming. Eric Wang provided excellent research assistance in computation on the Linux operating system. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Christopher A. Sims, Department of Economics, 104 Fisher Hall, Princeton University, Princeton, New Jersey 08544-1021, 609-258-4033,, or Tao Zha, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street N.E., Atlanta, Georgia 30309-4470, 404-498-8353,