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Asymmetric expectation effects of regime shifts and the Great Moderation

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Zheng Liu
Daniel F. Waggoner
Tao Zha

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Abstract

The possibility of regime shifts in monetary policy can have important effects on rational agents' expectation formation and equilibrium dynamics. In a dynamic stochastic general equilibrium model where the monetary policy rule switches between a dovish regime that accommodates inflation and a hawkish regime that stabilizes inflation, the expectation effect is asymmetric across regimes. Such an asymmetric effect makes it difficult but still possible to generate substantial reductions in the volatilities of inflation and output as the monetary policy switches from the dovish regime to the hawkish one.

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Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2007-23.

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Date of creation: 2007
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Handle: RePEc:fip:fedawp:2007-23

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