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

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 macro-economy. Monetary policy is identi fied 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 in flation- output trade-off more favorable. The large drop in in flation 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