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Endogenous monetary policy regime change

  • Troy A. Davig
  • Eric M. Leeper

This paper makes changes in monetary policy rules (or regimes) endogenous. Changes are triggered when certain endogenous variables cross specified thresholds. Rational expectations equilibria are examined in three models of threshold switching to illustrate that (i) expectations formation effects generated by the possibility of regime change can be quantitatively important; (ii) symmetric shocks can have asymmetric effects; (iii) endogenous switching is a natural way to formally model preemptive policy actions. In a conventional calibrated model, preemptive policy shifts agents’ expectations, enhancing the ability of policy to offset demand shocks; this yields a quantitatively significant “preemption dividend.”

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 06-11.

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Date of creation: 2006
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Handle: RePEc:fip:fedkrw:rwp06-11
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