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Learning and monetary policy shifts

  • Frank Schorfheide

This paper estimates a dynamic stochastic equilibrium model in which agents use a Bayesian rule to learn about the state of monetary policy. Monetary policy follows a nominal interest rate rule that is subject to regime shifts. The following results are obtained. First, the author's policy regime estimates are consistent with the popular view that policy was marked by a shift to a high-inflation regime in the early 1970s, which ended with Volcker's stabilization policy at the beginning of the 1980s. Second, while Bayesian posterior odds favor the "full-information" version of the model in which agents know the policy regime, the fall of inflation and interest rates in the disinflation episode in the early 1980s is better captured by the delayed response of the "learning" specification. Third, the author examines the magnitude of the expectations-formation effect of monetary policy interventions in the "learning" specification by comparing impulse responses to a version of the model in which agents ignore the information contained in current and past monetary policy shocks about the likelihood of a regime shift.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta Working Paper with number 2003-23.

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Date of creation: 2003
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Handle: RePEc:fip:fedawp:2003-23
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  1. Frank Schorfheide, 2000. "Loss function-based evaluation of DSGE models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(6), pages 645-670.
  2. Giorgio Primiceri, 2005. "Why Inflation Rose and Fell: Policymakers' Beliefs and US Postwar Stabilization Policy," NBER Working Papers 11147, National Bureau of Economic Research, Inc.
  3. Christopher A. Sims & Tao Zha, 2002. "Macroeconomic switching," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  4. Marco Del Negro & Frank Schorfheide, 2004. "Priors from General Equilibrium Models for VARS," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 643-673, 05.
  5. Thomas Lubik & Frank Schorfheide, 2002. "Testing for Indeterminacy in Linear Rational Expectations Models," Computing in Economics and Finance 2002 214, Society for Computational Economics.
  6. David Andolfatto & Paul Gomme, 2001. "Monetary policy regimes and beliefs," Working Paper 9905, Federal Reserve Bank of Cleveland.
  7. Jesus Fernandez-Villaverde & Juan F. Rubio-Ramirez, 2004. "Estimating Nonlinear Dynamic Equilibrium economies: A Likelihood Approach," PIER Working Paper Archive 04-001, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  8. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
  9. Christopher J. Erceg and Andrew T. Levin, 2001. "Imperfect Credibility and Inflation Persistence," Computing in Economics and Finance 2001 19, Society for Computational Economics.
  10. Chib S. & Jeliazkov I., 2001. "Marginal Likelihood From the Metropolis-Hastings Output," Journal of the American Statistical Association, American Statistical Association, vol. 96, pages 270-281, March.
  11. John F. Geweke, 1998. "Using simulation methods for Bayesian econometric models: inference, development, and communication," Staff Report 249, Federal Reserve Bank of Minneapolis.
  12. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  13. Timothy Cogley & Thomas J. Sargent, 2005. "The conquest of US inflation: Learning and robustness to model uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 528-563, April.
  14. Kozicki, Sharon & Tinsley, P. A., 2001. "Shifting endpoints in the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 613-652, June.
  15. Eric M. Leeper & Tao Zha, 2002. "Modest policy interventions," FRB Atlanta Working Paper 2002-19, Federal Reserve Bank of Atlanta.
  16. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  17. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  18. David Andolfatto & Scott Hendry & Kevin Moran, 2004. "Inflation Expectations and Learning about Monetary Policy," DNB Staff Reports (discontinued) 121, Netherlands Central Bank.
  19. Christopher A. Sims, 1982. "Policy Analysis with Econometric Models," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 13(1), pages 107-164.
  20. Chang-Jin Kim & Charles R. Nelson, 1999. "State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262112388, June.
  21. 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.
  22. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The Conquest of South American Inflation," NBER Working Papers 12606, National Bureau of Economic Research, Inc.
  23. Kim, Chang-Jin, 1994. "Dynamic linear models with Markov-switching," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 1-22.
  24. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  25. 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.
  26. Sims, Christopher A, 2002. "Solving Linear Rational Expectations Models," Computational Economics, Society for Computational Economics, vol. 20(1-2), pages 1-20, October.
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