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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. David Andolfatto & Paul Gomme, 1997. "Monetary Policy Regimes and Beliefs," Cahiers de recherche CREFE / CREFE Working Papers 48, CREFE, Université du Québec à Montréal, revised Apr 2001.
  2. Eric M. Leeper & Tao Zha, 2002. "Modest Policy Interventions," NBER Working Papers 9192, National Bureau of Economic Research, Inc.
  3. Troy Davig & Eric M. Leeper, 2006. "Generalizing the Taylor Principle," Caepr Working Papers 2006-001, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  4. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February.
  5. Frederic S. Mishkin, 2004. "Why the Federal Reserve Should Adopt Inflation Targeting," International Finance, Wiley Blackwell, vol. 7(1), pages 117-127, 03.
  6. 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.
  7. Christopher A. Sims & Tao Zha, 2004. "Were there regime switches in U.S. monetary policy?," Working Paper 2004-14, Federal Reserve Bank of Atlanta.
  8. Noah Williams & Lars E.O. Svensson, 2005. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," Computing in Economics and Finance 2005 108, Society for Computational Economics.
  9. 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.
  10. Boivin, Jean & Giannoni, Marc, 2006. "Has Monetary Policy Become More Effective?," CEPR Discussion Papers 5463, C.E.P.R. Discussion Papers.
  11. Frank Schorfheide, 2003. "Learning and monetary policy shifts," Working Paper 2003-23, Federal Reserve Bank of Atlanta.
  12. 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.
  13. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  14. Benjamin M. Friedman, 2004. "Why the Federal Reserve Should Not Adopt Inflation Targeting," International Finance, Wiley Blackwell, vol. 7(1), pages 129-136, 03.
  15. 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.
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Cited by:
  1. 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.
  2. Marcelo Ferman, 2011. "Switching Monetary Policy Regimes and the Nominal Term Structure," FMG Discussion Papers dp678, Financial Markets Group.
  3. 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.
  4. Sharon Kozicki & P.A. Tinsley, 2007. "Term Structure Transmission of Monetary Policy," Working Papers 07-30, Bank of Canada.
  5. Zheng Liu & Daniel F. Waggoner & Tao Zha, 2007. "Asymmetric expectation effects of regime shifts and the Great Moderation," Working Paper 2007-23, Federal Reserve Bank of Atlanta.
  6. Roger E.A. Farmer & Daniel F. Waggoner & Tao Zha, 2008. "Generalizing the Taylor principle: comment," Working Paper 2008-19, Federal Reserve Bank of Atlanta.
  7. 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, vol. 12(2), pages 284-303, April.
  8. 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, vol. 44(1), pages 74-90, March.
  9. Vidakovic, Neven, 2014. "Exchange rate regime and household's choice of debt," MPRA Paper 54219, University Library of Munich, Germany.

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