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Perturbation methods for Markov-switching DSGE model

  • Andrew Foerster
  • Juan Rubio-Ramirez
  • Dan Waggoner
  • Tao Zha

The macroeconomic environment often changes repeatedly over time, and often in a recurring manner. For example, the economy may switch between periods of high and low growth, or monetary policy may switch between periods of strong versus weak responses to inflation. An important question for economists is how to model the presence of these switches, and to capture how expectations about switches in the future may impact economic behavior. ; This paper develops a methodology for solving dynamic stochastic general equilibrium (DSGE) models in the presence of switching environments. The approach allows for features of the economy to change over time, and for consumers, firms, or policymakers to internalize the expectations of future changes on their behavior. ; the procedure. In one example, the economy switches between a high and low growth periods. In the second example, the monetary authority changes how strongly it responds to deviations of inflation from its inflation target. Both examples highlight that expectations of future changes impact behavior in important ways.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 13-01.

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Date of creation: 2013
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Handle: RePEc:fip:fedkrw:rwp13-01
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