IDEAS home Printed from https://ideas.repec.org/p/inu/caeprp/2008-011.html
   My bibliography  Save this paper

Regime Switching, Learning, and the Great Moderation

Author

Listed:
  • James Murray

    () (Indiana University Bloomington)

Abstract

This paper examines the "bad luck" explanation for changing volatility in U.S. inflation and output when agents do not have rational expectations, but instead form expectations through least squares learning with an endogenously changing learning gain. It has been suggested that this type of endogenously changing learning mechanism can create periods of excess volatility without the need for changes in the variance of the underlying shocks. Bad luck is modeled into a standard New Keynesian model by augmenting it with two states that evolve according to a Markov chain, where one state is characterized by large variances for structural shocks, and the other state has relatively smaller variances. To assess whether learning can explain the Great Moderation, the New Keynesian model with volatility regime switching and dynamic gain learning is estimated by maximum likelihood. The results show that learning does lead to lower variances for the shocks in the volatile regime, but changes in regime is still significant in differences in volatility from the 1970s and after the 1980s.

Suggested Citation

  • James Murray, 2008. "Regime Switching, Learning, and the Great Moderation," Caepr Working Papers 2008-011, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  • Handle: RePEc:inu:caeprp:2008-011
    as

    Download full text from publisher

    File URL: http://www.iub.edu/~caepr/RePEc/PDF/2008/CAEPR2008-011.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Raf Wouters & Frank Smets, 2005. "Comparing shocks and frictions in US and euro area business cycles: a Bayesian DSGE Approach," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 20(2), pages 161-183.
    2. Giorgio E. Primiceri, 2006. "Why Inflation Rose and Fell: Policy-Makers' Beliefs and U. S. Postwar Stabilization Policy," The Quarterly Journal of Economics, Oxford University Press, vol. 121(3), pages 867-901.
    3. Bruce Preston, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
    4. Albert Marcet & Juan P. Nicolini, 2003. "Recurrent Hyperinflations and Learning," American Economic Review, American Economic Association, vol. 93(5), pages 1476-1498, December.
    5. James Murray, 2008. "Empirical Significance of Learning in a New Keynesian Model with Firm-Specific Capital," Caepr Working Papers 2007-027, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    6. Christopher A. Sims & Tao Zha, 2006. "Were There Regime Switches in U.S. Monetary Policy?," American Economic Review, American Economic Association, vol. 96(1), pages 54-81, March.
    7. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
    8. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
    9. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    10. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Learning; regime switching; great moderation; New Keynesian model; maximum likelihood;

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:inu:caeprp:2008-011. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Center for Applied Economics and Policy Research). General contact details of provider: http://edirc.repec.org/data/caeprus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.