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Realized and Optimal Monetary Policy Rules in an Estimated Markov‐Switching DSGE Model of the United Kingdom

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  • XIAOSHAN CHEN
  • RONALD MACDONALD

Abstract

This paper conducts a systematic investigation of parameter instability in a small open economy DSGE model of the UK economy over the past thirty-five years. Using Bayesian analysis, we find a number of Markov-switching versions of the model provide a better fit for the UK data than a model with time-invariant parameters. The Markov-switching DSGE model that has two independent Markov-chains - one governing the shifts in UK monetary policy and nominal price rigidity and one governing the standard deviations of shocks - is selected as the best fitting model. The preferred model is then used to evaluate and design monetary policy. For the latter, we use the Markov-Jump-Linear-Quadratic (MJLQ) model, as it incorporates abrupt changes in structural parameters into derivations of the optimal and arbitrary policy rules. It also reveals the entire forecasting distribution of the targeted variables. To our knowledge, this is the first paper that attempts to evaluate and design UK monetary policy based on an estimated open economy Markov-switching DSGE model.

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File URL: http://hdl.handle.net/10.1111/j.1538-4616.2012.00524.x
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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 44 (2012)
Issue (Month): 6 (09)
Pages: 1091-1116

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Handle: RePEc:mcb:jmoncb:v:44:y:2012:i:6:p:1091-1116

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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Cited by:
  1. António AFONSO & Priscilla TOFFANO, 2013. "Fiscal regimes in the EU," Center for Economic Studies - Discussion papers ces13.06, Katholieke Universiteit Leuven, Centrum voor Economische Studiën.
  2. Marian Vavra, 2013. "Testing for linear and Markov switching DSGE models," Working and Discussion Papers WP 3/2013, Research Department, National Bank of Slovakia.
  3. Xiaoshan Chen & Tatiana Kirsanova & Campbell Leith, 2013. "How Optimal is US Monetary Policy?," Working Papers 2013_08, Business School - Economics, University of Glasgow.
  4. Caglayan, Mustafa & Jehan, Zainab & Mouratidis, Kostas, 2012. "Asymmetric monetary policy rules for open economies: Evidence from four countries," MPRA Paper 37401, University Library of Munich, Germany.

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