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Expectational stability in regime-switching rational expectations models

  • William A. Branch
  • Troy Davig
  • Bruce McGough

Regime-switching rational expectations models, in which the parameters of the model evolve according to a finite state Markov process, have properties that differentiate them from linear models. Issues that are well understood in linear contexts, such as equilibrium determinacy and stability under adaptive learning, re-emerge in this new context. This paper outlines these issues and defines two classes of equilibria that emerge from regime-switching models. The distinguishing feature between the two classes is whether the conditional density of the endogenous state variables depends on past regimes. An assumption on whether agents condition their expectations on past regimes has important implications for determinacy and equilibrium dynamics. The paper addresses the stability properties of the different classes of equilibria under adaptive learning, extending the learning literature to a non-linear framework.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 07-09.

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Date of creation: 2007
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Handle: RePEc:fip:fedkrw:rwp07-09
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  1. Eric M. Leeper & Tao Zha, 1999. "Modest policy interventions," Working Paper 99-22, Federal Reserve Bank of Atlanta.
  2. Troy Davig & Eric M. Leeper, 2005. "Generalizing the Taylor Principle," NBER Working Papers 11874, National Bureau of Economic Research, Inc.
  3. Roger E.A. Farmer & Daniel F. Waggoner & Tao Zha, 2007. "Indeterminacy in a forward-looking regime-switching model," Working Paper 2006-19, Federal Reserve Bank of Atlanta.
  4. Hess Chung & Troy Davig & Eric Leeper, 2004. "Monetary and Fiscal Policy Switching," Econometric Society 2004 North American Summer Meetings 274, Econometric Society.
  5. David Andolfatto & Paul Gomme, 1997. "Monetary Policy Regimes and Beliefs," Working Papers 97002, University of Waterloo, Department of Economics, revised Jan 1997.
  6. Zampolli, Fabrizio, 2006. "Optimal monetary policy in a regime-switching economy: The response to abrupt shifts in exchange rate dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1527-1567.
  7. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  8. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  9. Lars Svensson & Noah Williams, 2005. "Monetary Policy with Model Uncertainty: Distribution Forecast Targeting," NBER Working Papers 11733, National Bureau of Economic Research, Inc.
  10. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  11. Thomas Lubik & Frank Schorfheide, 2002. "Testing for Indeterminacy:An Application to U.S. Monetary Policy," Economics Working Paper Archive 480, The Johns Hopkins University,Department of Economics, revised Jun 2003.
  12. Davig, Troy, 2004. "Regime-switching debt and taxation," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 837-859, May.
  13. Evans, George W. & McGough, Bruce, 2005. "Stable sunspot solutions in models with predetermined variables," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 601-625, April.
  14. Bray, Margaret M & Savin, Nathan E, 1986. "Rational Expectations Equilibria, Learning, and Model Specification," Econometrica, Econometric Society, vol. 54(5), pages 1129-60, September.
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