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Taylor-type rules versus optimal policy in a Markov-switching economy

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Author Info

  • Fernando Alexandre

    (NIPE and University of Minho)

  • Pedro Bação

    ()
    (GEMF and Faculdade de Economia, Universidade de Coimbra)

  • Vasco Gabriel

    (Department of Economics, University of Surrey, UK and NIPE-UM)

Abstract

We analyse the effect of uncertainty concerning the state and the nature of asset price movements on the optimal monetary policy response. Uncertainty is modeled by adding Markov-switching shocks to a DSGE model with capital accumulation. In our analysis we consider both Taylor-type rules and optimal policy. Taylor rules have been shown to provide a good description of US monetary policy. Deviations from its implied interest rates have been associated with risks of financial disruptions. Whereas interest rates in Taylor-type rules respond to a small subset of information, optimal policy considers all state variables and shocks. Our results suggest that, when a bubble bursts, the Taylor rule fails to achieve a soft landing, contrary to the optimal policy.

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Bibliographic Info

Paper provided by GEMF - Faculdade de Economia, Universidade de Coimbra in its series GEMF Working Papers with number 2008-02.

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Length: 37 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:gmf:wpaper:2008-02

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Keywords: Asset Prices; Monetary Policy; Markov Switching;

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Citations

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Cited by:
  1. Fernando Alexandre & Miguel Portela & Carla Sá, 2008. "Admission conditions and graduates' employability," NIPE Working Papers, NIPE - Universidade do Minho 16/2008, NIPE - Universidade do Minho.
  2. Alexandre, Fernando & Bação, Pedro & Gabriel, Vasco, 2010. "Soft landing in a Markov-switching economy," Economics Letters, Elsevier, Elsevier, vol. 107(2), pages 169-172, May.
  3. Paulo Bastos & Natália P. Monteiro, 2011. "Managers and Wage Policies," Journal of Economics & Management Strategy, Wiley Blackwell, Wiley Blackwell, vol. 20(4), pages 957-984, December.

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