events. third, monetary policy can also affect the distribution of measured shocks by changing the sensitivity of pricing and other economic decisions to exogenous outside events. for example, significant movements in the price of oil and other commodities continued to occur after 1984. however, in a low - inflation environment, with stable inflation expectations and a general perception that firms do not have pricing power, commodity price shocks are not passed into final goods prices to nearly the same degree as in a looser monetary environment. as a result, a change in commodity prices of a given size shows up as a smaller shock to output and consumer prices today than it would have in the earlier period. likewise, there is evidence that fluctuations in exchange rates have smaller effects on domestic prices and economic activity when inflation is less volatile and inflation expectations are stabilized ( gagnon and ihrig, 2002 ; devereux, engel, and storgaard, 2003 ). fourth, changes in inflation expectations, which are ultimately the product of the monetary policy regime, can also be confused with truly exogenous shocks in conventional econometric analyses. marvin goodfriend ( 1993 ) has suggested, for example, that insufficiently anchored inflation expectations have led to periodic “ inflation scares ”, in which inflation expectations have risen in an apparently autonomous manner. increases in inflation expectations have the flavor of adverse aggregate supply shocks in that they tend to increase the volatility of both inflation and output, in a combination that depends on how strongly the monetary policymakers act to offset these changes in expectations. theoretical and empirical support for the idea that inflation expectations may become an independent source of instability has grown in recent years. 12 as i mentioned earlier, a number of researchers have found that the reaction of monetary policymakers to inflation has strengthened, in that the estimated coefficient on inflation in the taylor rule has risen from something less than 1 before 1979 to a value significantly greater than 1 in the more recent period. if the policy interest rate responds to increases in inflation by less than one - for - one ( so that the real policy rate does not rise in the face of higher inflation ), economic theory tells us that inflation expectations and the economy in general can become unstable. the problem arises from the fact that, if policymakers do not react sufficiently aggressively to increases in inflation, spontaneously arising expectations of increased inflation can ultimately be selfconfirming and even self - reinforcing. incidentally, the stability requirement that the policy rate respond to inflation by more

and stability. the second class of explanations focuses on the arguably improved performance of macroeconomic policies, particularly monetary policy. the historical pattern of changes in the volatilities of output growth and inflation gives some credence to the idea that better monetary policy may have been a major contributor to increased economic stability. as blanchard and simon ( 2001 ) show, output volatility and inflation volatility have had a strong tendency to move together, both in the united states and other industrial countries. in particular, output volatility in the united states, at a high level in the immediate postwar era, declined significantly between 1955 and 1970, a period in which inflation volatility was low. both output volatility and inflation volatility rose significantly in the 1970s and early 1980s and, as i have noted, both fell sharply after about 1984. economists generally agree that the 1970s, the period of highest volatility in both output and inflation, was also a period in which monetary kim and nelson ( 1999 ) and mcconnell and perez - quiros ( 2000 ) were among the first to note the reduction in the volatility of output. kim, nelson, and piger ( 2003 ) show that the reduction in the volatility of output is quite broad based, affecting many sectors and aspects of the economy. warnock and warnock ( 2000 ) find a parallel decline in the volatility of employment, especially in goods - producing sectors. the united states has experienced only two relatively mild recessions since 1984, compared with four recessions - two of them quite deep - in the fifteen years before 1984. indeed, according to the national bureau of economic research ’ s monthly business cycle chronology, which covers the period since the civil war, the 120 - month expansion of the 1990s was the longest recession - free period the united states has enjoyed, and the 92 - month expansion of the 1980s was the third longest such period. mcconnell and perez - quiros ( 2000 ) and kahn, mcconnell, and perez - quiros ( 2002 ) make this argument. mccarthy and zakrajsek ( 2003 ) provide an overview and evaluation of this literature ; they conclude that better inventory management has reinforced the trend toward lower volatility but is not the ultimate cause. willis ( 2003 ) discusses structural changes that may have contributed to reduced variability of inflation. policy performed quite poorly, relative to both earlier and later periods ( romer and romer, 2002 ). 4 few disagree that monetary policy has