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Expectation Effects of Regimes Shifts in Monetary Policy

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  • Zheng Liu
  • Daniel F. Waggoner
  • Tao Zha

Abstract

We assess the quantitative importance of expectation effects of regime shifts in monetary policy in a DSGE model that allows the monetary policy rule to switch between a “bad” regime and a ”good” regime. When agents take into account such regime shifts in forming expectations, the expectation effect is asymmetric. In the good regime, the expectation effect is small despite agents’ disbelief that the regime will last forever. In the bad regime, however, the expectation effect on equilibrium dynamics of inflation and output is quantitatively important, even if agents put a small probability that monetary policy will switch to the good regime. Although the expectation effect dampens aggregate fluctuations in the bad regime, a switch from the bad regime to the good regime can still substantially reduce the volatility of both inflation and output, provided that we allow some “reduced-form” parameters in the private sector to change with monetary policy regime.

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1357.

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Length: 42 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:kie:kieliw:1357

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Cited by:
  1. Yongsung Chang & Sun-Bin Kim & Frank Schorfheide, 2010. "Labor-Market Heterogeneity, Aggregation, and the Lucas Critique," NBER Working Papers 16401, National Bureau of Economic Research, Inc.
  2. Andrew Mountford & Harald Uhlig, 2005. "What are the Effects of Fiscal Policy Shocks?," SFB 649 Discussion Papers SFB649DP2005-039, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  3. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2009. "Sources of the Great Moderation: shocks, frictions, or monetary policy?," Working Paper 2009-03, Federal Reserve Bank of Atlanta.
  4. Ferman, Marcelo, 2011. "Switching Monetary Policy Regimes and the Nominal Term Structure," Dynare Working Papers 5, CEPREMAP.
  5. Sun-Bin Kim & Frank Schorfheide & Yongsung Chang, 2010. "Financial Frictions, Aggregation, and the Lucas Critique," 2010 Meeting Papers 31, Society for Economic Dynamics.

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