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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
Date of revision:
Handle: RePEc:fip:fedkrw:rwp07-09
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  1. Eric M. Leeper & Tao Zha, 1999. "Modest policy interventions," FRB Atlanta Working Paper No. 99-22, Federal Reserve Bank of Atlanta.
  2. Roger E.A. Farmer & Daniel F. Waggoner & Tao Zha, 2007. "Indeterminacy in a forward-looking regime-switching model," FRB Atlanta Working Paper No. 2006-19, Federal Reserve Bank of Atlanta.
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  4. 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.
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  8. Hess Chung & Troy Davig & Eric Leeper, 2004. "Monetary and Fiscal Policy Switching," Computing in Economics and Finance 2004 325, Society for Computational Economics.
  9. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  10. 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.
  11. Bray, Margaret M & Savin, Nathan E, 1986. "Rational Expectations Equilibria, Learning, and Model Specification," Econometrica, Econometric Society, vol. 54(5), pages 1129-60, September.
  12. 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.
  13. 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.
  14. Davig, Troy, 2004. "Regime-switching debt and taxation," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 837-859, May.
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