From Shocks to Policy: The Evolution and Impact of Stock and Watson 2001 After a Quarter Century

Abstract

Evaluating the structural stability of the relationships between inflation, unemployment, and interest rates is vital for central banks striving to fulfill their dual mandates within an evolving economic landscape. This study evaluates whether the empirical dynamics governing these fundamental macroeconomic relationships have undergone significant parameter shifts over the past quarter century. Utilizing quarterly US macroeconomic data from 2001 to 2025, this study employs a recursive vector autoregression (VAR) framework that incorporates the federal funds rate alongside broader measures of labor market slack: the U6 unemployment rate) and decomposed price pressures (demand-driven inflation). Information criteria definitively show that this model offers a superior empirical fit, while the resulting impulse response functions reveal a weak, unstable response of unemployment to policy shocks that directly contradicts traditional historical benchmarks. Ultimately, this study contributes to the literature by demonstrating that fixed-parameter linear frameworks lack the structural robustness required to capture modern post-pandemic macroeconomic interactions, highlighting a critical need for time-varying analytical models.