This paper examines monetary regime switching in Canada and the United States and the implications of regime switching for exchange rates and key nominal and real macroeconomic aggregates for the two countries. Evidence of Markov regime switching in the process governing monetary base growth and in the bilateral exchange rate between the two countries is presented. Given this evidence, a two-country general equilibrium monetary model is constructed to account for observed properties of the U.S.-Canadian dollar exchange rate and for measured effects of monetary policy on key variables. Agents in the model face a monetary policy process with regime switching and form beliefs about regimes and money growth using observations and Bayesian learning. With the driving process for money growth rates parameterized using estimates from U.S. and Canadian data, quantitative implications of the model for behaviors of exchange rates and other key variables are examined. The findings are that inc lusion of learning by agents contributes somewhat to the model's ability to account for persistence in effects of money shocks on variables, provided that the shocks themselves are persistent; inclusion of learning contributes little in accounting for business cycle fluctuations and exchange rate variability; inclusion of a nonlinear driving process for money growth rates is important for the model to account for long swings in exchange rates; inclusion of learning adds only slightly to the ability of the model to account for long swings. The importance of nonlinearities in the driving process and the relative lack of importance of learning are consistent with other findings in the literature of learning effects in the face of regime switches.
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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number
99-13.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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.
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