Fed policy shifts reveal simple formula for economic stability.
The study found that estimates of Federal Reserve policy rules before 1979 were misleading. Before 1979, Fed policy changed the real funds rate in response to the output gap, not inflation. During the Volcker period, the policy kept the real funds rate high and constant, with no response to the output gap. By considering these changes, a simple funds rate equation using only inflation and output gap can be estimated effectively.