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Monetary Policy, Financial Frictions and Structural Changes: A Markov-Switching DSGE approach

Author

Listed:
  • Francis Leni Anguyo

    (School of Economics, University of Cape Town)

  • Rangan Gupta

    (Department of Economics, University of Pretoria)

  • Kevin Kotze

    (School of Economics, University of Cape Town)

Abstract

This paper considers the use of regime-switching dynamic stochastic general equilibrium models for monetary policy analysis and forecasting purposes. The model incorporates financial frictions that are introduced through the activities of heterogeneous agents in the household and several other features that are incorporated in most small open-economy models. Two variants of regime-switching models are considered: one includes switching in the monetary policy rule (only) and the other employs switching in both the monetary policy rule and the volatility of the shocks. The models are applied to the quarterly macroeconomic data for Uganda and most of the parameters are estimated with the aid of Bayesian techniques. The results of the extensive in- and out-of-sample evaluation suggest that the model parameters do not remain constant over the two regimes. In addition, the transition probabilities suggest that the nature of the regime-switching is consistent with the existence of isolated pulse effects that relate to significant shocks which affected the Ugandan economy, rather than level shifts in the central bank policy rule. It is also noted that the forecasting performance of the regime-switching models is possibly superior to the model that excludes these features.

Suggested Citation

  • Francis Leni Anguyo & Rangan Gupta & Kevin Kotze, 2017. "Monetary Policy, Financial Frictions and Structural Changes: A Markov-Switching DSGE approach," School of Economics Macroeconomic Discussion Paper Series 2017-05, School of Economics, University of Cape Town.
  • Handle: RePEc:ctn:dpaper:2017-05
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    References listed on IDEAS

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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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