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Monetary policy regime switches and macroeconomic dynamic

  • Andrew T. Foerster

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.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 13-04.

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Date of creation: 2013
Date of revision:
Handle: RePEc:fip:fedkrw:rwp13-04
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