Realised and Optimal Monetary Policy Rules in an Estimated Markov-Switching DSGE Model of the United Kingdom
AbstractThis 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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Bibliographic InfoPaper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2011_04.
Date of creation: Jan 2011
Date of revision:
DSGE models; Markov-switching; Bayesian analysis;
Other versions of this item:
- Xiaoshan Chen & Ronald Macdonald, 2012. "Realized and Optimal Monetary Policy Rules in an Estimated Markov‐Switching DSGE Model of the United Kingdom," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(6), pages 1091-1116, 09.
- Chen, Xiaoshan & MacDonald, Ronald, 2011. "Realised and Optimal Monetary Policy Rules in an Estimated Markov-Switching DSGE Model of the United Kingdom," SIRE Discussion Papers 2011-21, Scottish Institute for Research in Economics (SIRE).
- C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-09 (All new papers)
- NEP-CBA-2011-04-09 (Central Banking)
- NEP-DGE-2011-04-09 (Dynamic General Equilibrium)
- NEP-FOR-2011-04-09 (Forecasting)
- NEP-MAC-2011-04-09 (Macroeconomics)
- NEP-MON-2011-04-09 (Monetary Economics)
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