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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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References

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  1. Lars Svensson & Noah Williams, 2005. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," NBER Working Papers 11733, National Bureau of Economic Research, Inc.
  2. Troy Davig & Eric M. Leeper, 2007. "Generalizing the Taylor Principle," American Economic Review, American Economic Association, American Economic Association, vol. 97(3), pages 607-635, June.
  3. Roger E.A. Farmer & Daniel F. Waggoner & Tao Zha, 2007. "Indeterminacy in a forward-looking regime-switching model," Working Paper, Federal Reserve Bank of Atlanta 2006-19, Federal Reserve Bank of Atlanta.
  4. Eric M. Leeper & Tao Zha, 2002. "Modest Policy Interventions," NBER Working Papers 9192, National Bureau of Economic Research, Inc.
  5. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 27(1), pages 129-147, February.
  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. 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.
  8. Frank Schorfheide, 2003. "Learning and monetary policy shifts," Working Paper, Federal Reserve Bank of Atlanta 2003-23, Federal Reserve Bank of Atlanta.
  9. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1908, C.E.P.R. Discussion Papers.
  10. Benjamin M. Friedman, 2004. "Why the Federal Reserve Should Not Adopt Inflation Targeting," International Finance, Wiley Blackwell, Wiley Blackwell, vol. 7(1), pages 129-136, 03.
  11. 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.
  12. Lubik, Thomas A. & Schorfheide, Frank, 2003. "Computing sunspot equilibria in linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 28(2), pages 273-285, November.
  13. Cooley, Thomas F & LeRoy, Stephen F & Raymon, Neil, 1984. "Econometric Policy Evaluation: Note," American Economic Review, American Economic Association, American Economic Association, vol. 74(3), pages 467-70, June.
  14. Christopher A. Sims & Tao Zha, 2006. "Were There Regime Switches in U.S. Monetary Policy?," American Economic Review, American Economic Association, American Economic Association, vol. 96(1), pages 54-81, March.
  15. Frederic S. Mishkin, 2004. "Why the Federal Reserve Should Adopt Inflation Targeting," International Finance, Wiley Blackwell, Wiley Blackwell, vol. 7(1), pages 117-127, 03.
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Cited by:
  1. Noah Williams & Lars E.O. Svensson, 2005. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," Computing in Economics and Finance 2005, Society for Computational Economics 108, Society for Computational Economics.
  2. Barthélemy, J. & Marx, M., 2011. "State-Dependent Probability Distributions in Non Linear Rational Expectations Models," Working papers, Banque de France 347, Banque de France.
  3. 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.
  4. Zheng Liu & Daniel Waggoner & Tao Zha, 2009. "Asymmetric Expectation Effects of Regime Shifts in Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(2), pages 284-303, April.
  5. Marcelo Ferman, 2011. "Switching Monetary Policy Regimes and the Nominal Term Structure," FMG Discussion Papers, Financial Markets Group dp678, Financial Markets Group.
  6. Pedro de Araujo & Roisin O’Sullivan & Nicole B. Simpson, 2013. "What Should be Taught in Intermediate Macroeconomics?," The Journal of Economic Education, Taylor & Francis Journals, Taylor & Francis Journals, vol. 44(1), pages 74-90, March.
  7. 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.
  8. Vidakovic, Neven, 2014. "Exchange rate regime and household's choice of debt," MPRA Paper 54219, University Library of Munich, Germany.
  9. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2007. "Asymmetric expectation effects of regime shifts and the Great Moderation," Working Papers, Federal Reserve Bank of Minneapolis 653, Federal Reserve Bank of Minneapolis.
  10. Sharon Kozicki & P.A. Tinsley, 2007. "Term Structure Transmission of Monetary Policy," Working Papers, Bank of Canada 07-30, Bank of Canada.

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