Time Consistent Policy in Markov Switching Models
In this paper we consider the quadratic optimal control problem with regime shifts and forward-looking agents. This extends the results of Zampolli (2003) who considered models without forward-looking expectations. Two algorithms are presented: The first algorithm computes the solution of a rational expectation model with random parameters or regime shifts. The second algorithm computes the time-consistent policy and the resulting Nash-Stackelberg equilibrium. The formulation of the problem is of general form and allows for model uncertainty and incorporation of policymakerâ€™s judgement. We apply these methods to compute the optimal (non-linear) monetary policy in a small open economy subject to (symmetric or asymmetric) risks of change in some of its key parameters such as inflation inertia, degree of exchange rate pass-through, elasticity of aggregate demand to interest rate, etc.. We normally find that the time-consistent response to risk is more cautious. Furthermore, the optimal response is in some cases non-monotonic as a function of uncertainty. We also simulate the model under assumptions that the policymaker and the private sector hold the same beliefs over the probabilities of the structural change and different beliefs (as well as different assumptions about the knowledge of each otherâ€™s reaction function).
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Leitemo, Kai & Soderstrom, Ulf, 2005.
"Simple monetary policy rules and exchange rate uncertainty,"
Journal of International Money and Finance,
Elsevier, vol. 24(3), pages 481-507, April.
- Kai Leitemo & Ulf Soderstrom, 2001. "Simple monetary policy rules and exchange rate uncertainty," Proceedings, Federal Reserve Bank of San Francisco, issue Mar, pages -.
- Leitemo, Kai & Söderström, Ulf, 2001. "Simple Monetary Policy Rules and Exchange Rate Uncertainty," Working Paper Series 122, Sveriges Riksbank (Central Bank of Sweden).
- Fershtman, Chaim, 1989.
"Fixed rules and decision rules : Time consistency and subgame perfection,"
Elsevier, vol. 30(3), pages 191-194, September.
- Fershtman, C., 1988. "Fixed Rules And Decision Rules: Time Consistency And Subgame Perfection," Papers 12-88, Tel Aviv.
- Ulf Soderstrom & Richard Dennis, 2003.
"How Important is Precommitment for Monetary Policy?,"
Computing in Economics and Finance 2003
49, Society for Computational Economics.
- Dennis, Richard & Soderstrom, Ulf, 2006. "How Important Is Precommitment for Monetary Policy?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(4), pages 847-872, June.
- Richard Dennis & Ulf Soderstrom, 2002. "How important is precommitment for monetary policy?," Working Paper Series 2002-10, Federal Reserve Bank of San Francisco.
- Dennis, Richard & Söderström, Ulf, 2002. "How Important Is Precommitment for Monetary Policy?," Working Paper Series 139, Sveriges Riksbank (Central Bank of Sweden).
- Roberds, William, 1987.
"Models of Policy under Stochastic Replanning,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 731-55, October.
- Swanson, Eric T., 2004. "Signal Extraction And Non-Certainty-Equivalence In Optimal Monetary Policy Rules," Macroeconomic Dynamics, Cambridge University Press, vol. 8(01), pages 27-50, February.
- Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-1311, July.
- repec:cup:macdyn:v:8:y:2004:i:1:p:27-50 is not listed on IDEAS
- Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination in Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc.
- Dennis, Richard, 2007.
"Optimal Policy In Rational Expectations Models: New Solution Algorithms,"
Cambridge University Press, vol. 11(01), pages 31-55, February.
- Richard Dennis, 2001. "Optimal policy in rational-expectations models: new solution algorithms," Working Paper Series 2001-09, Federal Reserve Bank of San Francisco.
- Tom Doan, "undated". "RATS programs to replicate Dennis Macroeconomic Dynamics 2007 optimal control," Statistical Software Components RTZ00043, Boston College Department of Economics.
- Tom Doan, "undated". "DSGECONTROL: RATS procedure to compute state space model adjustments for optimal control," Statistical Software Components RTS00056, Boston College Department of Economics.
- Christophe Planas & Alessandro Rossi, 2004. "Can inflation data improve the real-time reliability of output gap estimates?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 19(1), pages 121-133.
- Fabrizio Zampolli, 2004. "Optimal monetary policy in a regime-switching economy," Computing in Economics and Finance 2004 166, Society for Computational Economics.
- Sharon Kozicki, 2004. "How do data revisions affect the evaluation and conduct of monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 5-38.
When requesting a correction, please mention this item's handle: RePEc:sce:scecf5:134. 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: (Christopher F. Baum)
If references are entirely missing, you can add them using this form.