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Expectational stability in regime-switching rational expectations models

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  • William A. Branch
  • Troy Davig
  • Bruce McGough

Abstract

Regime-switching rational expectations models, in which the parameters of the model evolve according to a finite state Markov process, have properties that differentiate them from linear models. Issues that are well understood in linear contexts, such as equilibrium determinacy and stability under adaptive learning, re-emerge in this new context. This paper outlines these issues and defines two classes of equilibria that emerge from regime-switching models. The distinguishing feature between the two classes is whether the conditional density of the endogenous state variables depends on past regimes. An assumption on whether agents condition their expectations on past regimes has important implications for determinacy and equilibrium dynamics. The paper addresses the stability properties of the different classes of equilibria under adaptive learning, extending the learning literature to a non-linear framework.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 07-09.

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Date of creation: 2007
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Handle: RePEc:fip:fedkrw:rwp07-09

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Keywords: Rational expectations (Economic theory);

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  1. Eric M. Leeper & Tao Zha, 2002. "Modest policy interventions," Working Paper 2002-19, Federal Reserve Bank of Atlanta.
  2. Hess Chung & Troy Davig & Eric Leeper, 2004. "Monetary and Fiscal Policy Switching," Computing in Economics and Finance 2004 325, Society for Computational Economics.
  3. Bray, Margaret M & Savin, Nathan E, 1986. "Rational Expectations Equilibria, Learning, and Model Specification," Econometrica, Econometric Society, vol. 54(5), pages 1129-60, September.
  4. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  5. Lars Svensson & Noah Williams, 2005. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," NBER Working Papers 11733, National Bureau of Economic Research, Inc.
  6. Farmer, Roger E A & Waggoner, Daniel F & Zha, Tao, 2006. "Indeterminacy in a Forward Looking Regime Switching Model," CEPR Discussion Papers 5919, C.E.P.R. Discussion Papers.
  7. David Andolfatto & Paul Gomme, 2003. "Monetary Policy Regimes and Beliefs," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 1-30, February.
  8. Thomas A. Lubik & Frank Schorfheide, 2004. "Testing for Indeterminacy: An Application to U.S. Monetary Policy," American Economic Review, American Economic Association, vol. 94(1), pages 190-217, March.
  9. Evans, George W. & McGough, Bruce, 2005. "Stable sunspot solutions in models with predetermined variables," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 601-625, April.
  10. Zampolli, Fabrizio, 2006. "Optimal monetary policy in a regime-switching economy: The response to abrupt shifts in exchange rate dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1527-1567.
  11. Troy Davig & Eric M. Leeper, 2005. "Generalizing the Taylor principle," Research Working Paper RWP 05-13, Federal Reserve Bank of Kansas City.
  12. Davig, Troy, 2004. "Regime-switching debt and taxation," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 837-859, May.
  13. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  14. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
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