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Indeterminacy in a forward-looking regime switching model

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

This paper is about the properties of Markov switching rational expectations (MSRE) models. We present a simple monetary policy model that switches between two regimes with known transition probabilities. The first regime, treated in isolation, has a unique determinate rational expectations equilibrium and the second contains a set of indeterminate sunspot equilibria. We show that the Markov switching model, which randomizes between these two regimes, may contain a continuum of indeterminate equilibria. We provide examples of stationary sunspot equilibria and bounded sunspot equilibria which exist even when the MSRE model satisfies a 'generalized Taylor principle'. Our result suggests that it may be more difficult to rule out non-fundamental equilibria in MRSE models than in the single regime case where the Taylor principle is known to guarantee local uniqueness.

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Article provided by The International Society for Economic Theory in its journal International Journal of Economic Theory.

Volume (Year): 5 (2009)
Issue (Month): 1 ()
Pages: 69-84

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Handle: RePEc:bla:ijethy:v:5:y:2009:i:1:p:69-84
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  1. Svensson, Lars E O & Williams, Noah, 2007. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," CEPR Discussion Papers 6331, C.E.P.R. Discussion Papers.
  2. Troy Davig & Eric M. Leeper, 2007. "Generalizing the Taylor Principle," American Economic Review, American Economic Association, vol. 97(3), pages 607-635, June.
  3. Robert G. King, 2000. "The new IS-LM model : language, logic, and limits," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 45-103.
  4. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
  5. Farmer, Roger E.A. & Waggoner, Daniel F. & Zha, Tao, 2011. "Minimal state variable solutions to Markov-switching rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 35(12), pages 2150-2166.
  6. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
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