|9. Sensitivity of the Results to the Fed's Weight on Inflation|
|Equation 30, the interest rate reaction function, is estimated.
It is an estimate of Fed behavior. The coefficient estimate on
inflation in this equation is an estimate of how the Fed responds to
inflation regarding its interest rate policy. The experiment in this
chapter asks the question of how much different it would make regarding
fiscal-policy effects if the inflation coefficient were larger.
We have seen in Chapter 5, Experiment 5.1, how the economy responds to a decrease in COG when the interest rate reaction function is used. We now examine the question of how the results change when the Fed's weight on inflation is larger. We will make the inflation coefficient in equation 30 three times as large as the estimated value and then rerun Experiment 5.1 for this version of the model.
Experiment 9.1: Experiment 5.1 with more weight on inflation in equation 30
There are many other experiments of this type that you can perform. For example, you can change other coefficients in equation 30, say increasing the weight on unemployment, and examine how this affects the results of changing COG. You can also run different fiscal-policy experiments (other than just changing COG) once you have your new version of the model. Be sure each time you change a coefficient that you get a new base dataset (like BASEA above).