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Monetary policy in a Markov-switching VECM: implications for the cost of disinflation and the price puzzle

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  • Neville Francis
  • Michael T. Owyang

Abstract

Monetary policy VARs typically presume stability of the long-run outcomes. We introduce the possibility of switches in the long-run equilibrium in a cointegrated VAR by allowing both the covariance matrix and weighting matrix in the error-correction term to switch. We find that monetary policy alternates between sustaining long-run growth and disinflationary regimes. Allowing state changes can also help explain the price puzzle and justify the use of commodity prices as a corrective measure. Finally, we show that regime-switching has implications for disinflationary monetary policy and can explain the variety of sacrifice ratio estimates that exist in the literature.

Suggested Citation

  • Neville Francis & Michael T. Owyang, 2004. "Monetary policy in a Markov-switching VECM: implications for the cost of disinflation and the price puzzle," Working Papers 2003-001, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2003-001
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    References listed on IDEAS

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    Cited by:

    1. Tillmann, Peter, 2007. "Inflation regimes in the US term structure of interest rates," Economic Modelling, Elsevier, vol. 24(2), pages 203-223, March.
    2. PeterTillmann, 2004. "Cointegration and Regime-Switching Risk Premia in the U.S. Term Structure of Interest Rates," Computing in Economics and Finance 2004 53, Society for Computational Economics.
    3. Owyang, Michael T. & Ramey, Garey, 2004. "Regime switching and monetary policy measurement," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1577-1597, November.
    4. Neville Francis & Eric Ghysels & Michael T. Owyang, 2011. "The low-frequency impact of daily monetary policy shocks," Working Papers 2011-009, Federal Reserve Bank of St. Louis.
    5. Peter Tillmann, 2004. "Cointegration and Regime-Switching Risk Premia in the US Term Structure of Interest Rates," Econometric Society 2004 North American Summer Meetings 26, Econometric Society.
    6. repec:spr:empeco:v:54:y:2018:i:4:d:10.1007_s00181-017-1265-y is not listed on IDEAS

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    Keywords

    Monetary policy ; Econometric models;

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