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Monetary policy regime switches and macroeconomic dynamic

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  • Andrew T. Foerster

Abstract

This paper investigates how different monetary policy regime switching types impact macroeconomic dynamics. Policy switches that either affect the inflation target or the response to inflation deviations from target lead to different determinacy regions and different output, inflation, and interest rate distributions. With regime switching, the standard Taylor Principle breaks down in multiple ways; satisfying the Principle period-by-period is neither necessary nor sufficient for determinacy. Switching inflation targets primarily affects the economy's level, whereas switching inflation responses affects the variance. Even in periods with a fixed monetary policy rule, expectations of future policy switches produce different outcomes depending upon the switching type. Monetary authorities with given inflation objectives need to adjust their policy parameters to counteract expectations of future policy switches.

Suggested Citation

  • Andrew T. Foerster, 2013. "Monetary policy regime switches and macroeconomic dynamic," Research Working Paper RWP 13-04, Federal Reserve Bank of Kansas City.
  • Handle: RePEc:fip:fedkrw:rwp13-04
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    1. repec:fip:fedkrw:15-06 is not listed on IDEAS
    2. Marian Vavra, 2013. "Testing for linear and Markov switching DSGE models," Working and Discussion Papers WP 3/2013, Research Department, National Bank of Slovakia.
    3. Guido Ascari & Anna Florio & Alessandro Gobbi, 2016. "Monetary and Fiscal Policy Interactions: Leeper (1991) Redux," Economics Series Working Papers 788, University of Oxford, Department of Economics.
    4. Guido Ascari & Anna Florio & Alessandro Gobbi, 2017. "High Trend Inflation and Passive Monetary Detours," DEM Working Papers Series 135, University of Pavia, Department of Economics and Management.
    5. Smith, A. Lee, 2016. "When does the cost channel pose a challenge to inflation targeting central banks?," European Economic Review, Elsevier, vol. 89(C), pages 471-494.
    6. Qureshi, Irfan, 2015. "Monetary Policy Shifts and Central Bank Independence," MPRA Paper 81646, University Library of Munich, Germany, revised Sep 2017.
    7. Smith, Andrew Lee, 2015. "When does the cost channel pose a challenge to inflation targeting central banks?," Research Working Paper RWP 15-6, Federal Reserve Bank of Kansas City.
    8. LI, XI HAO & Gallegati, Mauro, 2015. "Stock-Flow Dynamic Projection," MPRA Paper 62047, University Library of Munich, Germany.
    9. Dongho Song, 2014. "Bond Market Exposures to Macroeconomic and Monetary Policy Risks," PIER Working Paper Archive 14-017, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    10. Ascari, Guido & Florio, Anna & Gobbi, Alessandro, 2017. "Controlling inflation with switching monetary and fiscal policies: expectations, fiscal guidance and timid regime changes," Research Discussion Papers 9/2017, Bank of Finland.

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