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Regime Switches, Agents’ Beliefs, and Post-World War II U.S. Macroeconomic Dynamics

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  • Francesco Bianchi

Abstract

The evolution of the U.S. economy over the last 50 years is examined through the lens of a micro-founded model that allows for changes in the behavior of the Federal Reserve and in the volatility of structural shocks. Agents are aware of the possibility of regime changes and their beliefs have an impact on the law of motion underlying the macroeconomy. The results support the view that there were regime switches in the conduct of monetary policy. However, the behavior of the Federal Reserve is identifi ed by repeated fluctuations between a Hawk- and a Dove- regime, instead of by the traditional pre- and post- Volcker structure. Counterfactual simulations show that if agents had anticipated the appointment of an extremely conservative Chairman, inflation would not have reached the peaks of the late '70s and the inflation-output trade-off would have been less severe. These "beliefs counterfactuals" are new in the literature. Finally, the paper provides a set of tools to handle some of the technical difficulties that arise in rational expectation models with Markov-switching regimes.

Suggested Citation

  • Francesco Bianchi, 2012. "Regime Switches, Agents’ Beliefs, and Post-World War II U.S. Macroeconomic Dynamics," Working Papers 12-04, Duke University, Department of Economics.
    • Handle: RePEc:duk:dukeec:12-04
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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General

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