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Monetary Regime Change and Business Cycles

  • Cúrdia, Vasco

    (Macroeconomic and Monetary Studies Function)

  • Finocchiaro, Daria


    (Research Department, Central Bank of Sweden)

This paper analyzes to what extent changes in monetary policy regimes influence the business cycle in a small open economy and investigates the impact of policy breaks on the estimation procedure. We estimate a DSGE model on Swedish data, explicitly taking into account the monetary regime change in 1993, from exchange rate targeting to inflation targeting. The results suggest that monetary policy reacted strongly to exchange rate movements in the former, and mostly to inflation in the latter. The external sector plays an important role in the economy and the international transmission mechanism is significantly affected by the choice of exchange rate regime. A counterfactual experiment that applies the inflation targeting policy rule on the disturbances from the exchange rate targeting period suggests that such a policy would have led to higher output and employment, but also to a depreciated currency, higher inflation and a more volatile economy. We also show evidence that ignoring the break in the estimation leads to spurious results for both the parameters associated with monetary policy as well as those that are policy-independent.

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Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 241.

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Length: 62 pages
Date of creation: 01 Apr 2010
Date of revision:
Handle: RePEc:hhs:rbnkwp:0241
Contact details of provider: Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Phone: 08 - 787 00 00
Fax: 08-21 05 31
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