Regime Switching, Learning, and the Great Moderation
AbstractThis paper examines the "bad luck" explanation for changing volatility in U.S. inflation and output when agents do not have rational expectations, but instead form expectations through least squares learning with an endogenously changing learning gain. It has been suggested that this type of endogenously changing learning mechanism can create periods of excess volatility without the need for changes in the variance of the underlying shocks. Bad luck is modeled into a standard New Keynesian model by augmenting it with two states that evolve according to a Markov chain, where one state is characterized by large variances for structural shocks, and the other state has relatively smaller variances. To assess whether learning can explain the Great Moderation, the New Keynesian model with volatility regime switching and dynamic gain learning is estimated by maximum likelihood. The results show that learning does lead to lower variances for the shocks in the volatile regime, but changes in regime is still significant in differences in volatility from the 1970s and after the 1980s.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington in its series Caepr Working Papers with number 2008-011.
Length: 36 pages
Date of creation: Apr 2008
Date of revision:
Learning; regime switching; great moderation; New Keynesian model; maximum likelihood;
Find related papers by JEL classification:
- C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-05-10 (All new papers)
- NEP-CBA-2008-05-10 (Central Banking)
- NEP-MAC-2008-05-10 (Macroeconomics)
- NEP-OPM-2008-05-10 (Open Economy Macroeconomic)
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.:
- Albert Marcet & Juan P. Nicolini, 2003.
"Recurrent Hyperinflations and Learning,"
American Economic Review,
American Economic Association, vol. 93(5), pages 1476-1498, December.
- Marcet, A. & Nicolini, J.P., 1997. "Recurrent Hyperinflations and Learning," Papers 9721, Centro de Estudios Monetarios Y Financieros-.
- Albert Marcet & Juan P. Nicolini, 1995. "Recurrent hyperinflations and learning," Economics Working Papers 244, Department of Economics and Business, Universitat Pompeu Fabra, revised Nov 2001.
- Marcet, Albert & Nicolini, Juan Pablo, 1998. "Recurrent Hyperinflations and Learning," CEPR Discussion Papers 1875, C.E.P.R. Discussion Papers.
- Raf Wouters & Frank Smets, 2005.
"Comparing shocks and frictions in US and euro area business cycles: a Bayesian DSGE Approach,"
Journal of Applied Econometrics,
John Wiley & Sons, Ltd., vol. 20(2), pages 161-183.
- Smets, Frank & Wouters, Rafael, 2004. "Comparing Shocks and Frictions in US and Euro Area Business Cycles: A Bayesian DSGE Approach," CEPR Discussion Papers 4750, C.E.P.R. Discussion Papers.
- Smets, Frank & Wouters, Raf, 2004. "Comparing shocks and frictions in US and euro area business cycles: a Bayesian DSGE approach," Working Paper Series 0391, European Central Bank.
- Frank Smets & Raf Wouters, 2004. "Comparing shocks and frictions in US and euro area business cycles: a Bayesian DSGE approach," Working Paper Research 61, National Bank of Belgium.
- Christopher A. Sims & Tao Zha, 2004.
"Were there regime switches in U.S. monetary policy?,"
2004-14, Federal Reserve Bank of Atlanta.
- Christopher A. Sims & Tao Zha, 2006. "Were There Regime Switches in U.S. Monetary Policy?," American Economic Review, American Economic Association, vol. 96(1), pages 54-81, March.
- Christopher A. Sims & Tao Zha, 2005. "Were There Regime Switches in U.S. Monetary Policy?," Working Papers 92, Princeton University, Department of Economics, Center for Economic Policy Studies..
- Bruce Preston, 2005.
"Learning about Monetary Policy Rules when Long-Horizon Expectations Matter,"
International Journal of Central Banking,
International Journal of Central Banking, vol. 1(2), September.
- Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," Working Paper 2003-18, Federal Reserve Bank of Atlanta.
- Preston, Bruce, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," MPRA Paper 830, University Library of Munich, Germany.
- Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
- Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
- Giorgio Primiceri, 2005. "Why Inflation Rose and Fell: Policymakers' Beliefs and US Postwar Stabilization Policy," NBER Working Papers 11147, National Bureau of Economic Research, Inc.
- James Murray, 2008. "Empirical Significance of Learning in a New Keynesian Model with Firm-Specific Capital," Caepr Working Papers 2007-027, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Center for Applied Economics and Policy Research).
If references are entirely missing, you can add them using this form.