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Understanding the New-Keynesian Model when Monetary Policy Switches Regimes

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  • Roger E.A. Farmer
  • Daniel F. Waggoner
  • Tao Zha

Abstract

This paper studies a New-Keynesian model in which monetary policy may switch between regimes. We derive sufficient conditions for indeterminacy that are easy to implement and we show that the necessary and sufficient condition for determinacy, provided by Davig and Leeper, is necessary but not sufficient. More importantly, we use a two-regime model to show that indeterminacy in a passive regime may spill over to an active regime, no matter how active the latter regime is. As a result, a passive monetary policy is more damaging than has been previously thought. Our results imply that the propagation of shocks in an active regime, such as that of the Federal Reserve in the post-1982 period, may be substantially affected by the possibility of a return to a passive regime of the kind that was followed in the 1960s and 1970s.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12965.

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Date of creation: Mar 2007
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Handle: RePEc:nbr:nberwo:12965

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  1. Eric M. Leeper & Tao Zha, 2003. "Modest policy interventions," Working Paper, Federal Reserve Bank of Atlanta 2003-24, Federal Reserve Bank of Atlanta.
  2. Svensson, Lars E. O. & Williams, Noah, 2005. "Monetary policy with model uncertainty: distribution forecast targeting," Discussion Paper Series 1: Economic Studies 2005,35, Deutsche Bundesbank, Research Centre.
  3. Frank Schorfheide, 2003. "Learning and monetary policy shifts," Working Paper, Federal Reserve Bank of Atlanta 2003-23, Federal Reserve Bank of Atlanta.
  4. Farmer, Roger E A & Waggoner, Daniel F & Zha, Tao, 2006. "Indeterminacy in a Forward Looking Regime Switching Model," CEPR Discussion Papers 5919, C.E.P.R. Discussion Papers.
  5. Benjamin M. Friedman, 2004. "Why the Federal Reserve Should Not Adopt Inflation Targeting," International Finance, Wiley Blackwell, vol. 7(1), pages 129-136, 03.
  6. David Andolfatto & Paul Gomme, 1997. "Monetary Policy Regimes and Beliefs," Cahiers de recherche CREFE / CREFE Working Papers, CREFE, Université du Québec à Montréal 48, CREFE, Université du Québec à Montréal, revised Apr 2001.
  7. Troy Davig & Eric M. Leeper, 2006. "Generalizing the Taylor Principle," Caepr Working Papers, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington 2006-001, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  8. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 195-214, December.
  9. 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..
  10. Lubik, Thomas A. & Schorfheide, Frank, 2003. "Computing sunspot equilibria in linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 28(2), pages 273-285, November.
  11. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  12. Cooley, Thomas F & LeRoy, Stephen F & Raymon, Neil, 1984. "Econometric Policy Evaluation: Note," American Economic Review, American Economic Association, vol. 74(3), pages 467-70, June.
  13. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  14. Jean Boivin & Marc P. Giannoni, 2006. "Has Monetary Policy Become More Effective?," The Review of Economics and Statistics, MIT Press, vol. 88(3), pages 445-462, August.
  15. Frederic S. Mishkin, 2004. "Why the Federal Reserve Should Adopt Inflation Targeting," International Finance, Wiley Blackwell, vol. 7(1), pages 117-127, 03.
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Citations

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Cited by:
  1. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2008. "Asymmetric expectation effects of regime shifts in monetary policy," Working Paper Series 2008-22, Federal Reserve Bank of San Francisco.
  2. Svensson, Lars E. O. & Williams, Noah, 2005. "Monetary policy with model uncertainty: distribution forecast targeting," Discussion Paper Series 1: Economic Studies 2005,35, Deutsche Bundesbank, Research Centre.
  3. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2007. "Asymmetric expectation effects of regime shifts and the Great Moderation," Working Paper, Federal Reserve Bank of Atlanta 2007-23, Federal Reserve Bank of Atlanta.
  4. Adam Cagliarini & Mariano Kulish, 2013. "Solving Linear Rational Expectations Models with Predictable Structural Changes," The Review of Economics and Statistics, MIT Press, vol. 95(1), pages 328-336, March.
  5. Marcelo Ferman, 2011. "Switching Monetary Policy Regimes and the Nominal Term Structure," FMG Discussion Papers dp678, Financial Markets Group.
  6. Vidakovic, Neven, 2014. "Exchange rate regime and household's choice of debt," MPRA Paper 54219, University Library of Munich, Germany.
  7. Simpson, Nicole & de Araujo, Pedro & O'Sullivan, Roisin, 2012. "What should be taught in Intermediate Macroeconomics?," Working Papers 2012-01, Department of Economics, Colgate University.
  8. Roger E.A. Farmer & Daniel F. Waggoner & Tao Zha, 2008. "Generalizing the Taylor principle: comment," Working Paper, Federal Reserve Bank of Atlanta 2008-19, Federal Reserve Bank of Atlanta.
  9. Magali Marx & Jean Barthelemy, 2013. "State-Dependent Probability Distributions in Non Linear Rational Expectations Models," 2013 Meeting Papers, Society for Economic Dynamics 576, Society for Economic Dynamics.
  10. Sharon Kozicki & P.A. Tinsley, 2007. "Term Structure Transmission of Monetary Policy," Working Papers 07-30, Bank of Canada.

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