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Optimal versus realized policy rules in a regime-switching framework

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  • Pardo, S.
  • Rautureau, N.
  • Vallée, T.

Abstract

In this paper we compare a deterministic model and a Markov switching model to analyze the behavior of the US economy and the Federal Reserve. We examine both optimal and empirical monetary policies for the US Federal Reserve between 1960 and 2008. We compare the optimal monetary policy to the actual interest rates and to the empirical reaction function. We also evaluate the sensitivity of the results to the preferences assigned to each objective. We find that there is no unique optimal solution that fits the Federal Reserve behavior over the entire period. The best fit to the actual interest rates is obtained by an optimal policy with preference switches following the rule: a high-volatility regime coincides with a priority on inflation alone while in a low-volatility regime there is equal policy priority on output stabilization and inflation.

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Bibliographic Info

Article provided by Elsevier in its journal Economic Modelling.

Volume (Year): 28 (2011)
Issue (Month): 6 ()
Pages: 2761-2775

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Handle: RePEc:eee:ecmode:v:28:y:2011:i:6:p:2761-2775

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Web page: http://www.elsevier.com/locate/inca/30411

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Keywords: Optimal monetary policy; Markov switching;

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References

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  1. Carlo A. Favero, . "Macroeconomic stability and the preferences of the Fed. A formal analysis, 1961-98," Working Papers 200, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  2. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
  3. Davig, Troy, 2004. "Regime-switching debt and taxation," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 837-859, May.
  4. Troy Davig & Eric M. Leeper, 2005. "Generalizing the Taylor Principle," NBER Working Papers 11874, National Bureau of Economic Research, Inc.
  5. Lars E.O. Svensson & Noah Williams, 2008. "Optimal monetary policy under uncertainty: a Markov jump-linear-quadratic approach," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 275-294.
  6. Andrew P Blake & Fabrizio Zampolli, 2006. "Optimal monetary policy in Markov-switching models with rational expectations agents," Bank of England working papers 298, Bank of England.
  7. Christopher A. Sims & Tao Zha, 2004. "Were there regime switches in U.S. monetary policy?," Working Paper 2004-14, Federal Reserve Bank of Atlanta.
  8. Richard Dennis, 2001. "The policy preferences of the U.S. Federal Reserve," Working Paper Series 2001-08, Federal Reserve Bank of San Francisco.
  9. Ozlale, Umit, 2003. "Price stability vs. output stability: tales of federal reserve administrations," Journal of Economic Dynamics and Control, Elsevier, vol. 27(9), pages 1595-1610, July.
  10. Richard Dennis, 2003. "Inferring policy objectives from economic outcomes," Working Paper Series 2003-05, Federal Reserve Bank of San Francisco.
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Cited by:
  1. André P. Calmon & Thomas Vallée & João B. R. Do Val, 2009. "Monetary policy as a source of uncertainty," Working Papers hal-00422454, HAL.

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