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Asymmetric Expectation Effects of Regime Shifts and the Great Moderation

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  • Liu, Zheng
  • Waggoner, Daniel F.
  • Zha, Tao

Abstract

We assess the quantitative importance of expectation effects of regime shifts in monetary policy in a DSGE model that allows the monetary policy rule to switch between a ?bad? regime and a ?good? regime. When agents take into account such regime shifts in forming expectations, the expectation effect is asymmetric. In the good regime, the expectation effect is small despite agents' disbelief that the regime will last forever. In the bad regime, however, the expectation effect on equilibrium dynamics of inflation and output is quantitatively important, even if agents put a small probability that monetary policy will switch to the good regime. Although the expectation effect dampens aggregate fluctuations in the bad regime, a switch from the bad regime to the good regime can still substantially reduce the volatility of both inflation and output, provided that we allow some ?reduced-form? parameters in the private sector to change with monetary policy regime.

Suggested Citation

  • Liu, Zheng & Waggoner, Daniel F. & Zha, Tao, 2007. "Asymmetric Expectation Effects of Regime Shifts and the Great Moderation," Kiel Working Papers 1357, Kiel Institute for the World Economy (IfW Kiel).
  • Handle: RePEc:zbw:ifwkwp:1357
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    Cited by:

    1. Andrew Mountford & Harald Uhlig, 2009. "What are the effects of fiscal policy shocks?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 24(6), pages 960-992.
    2. Zheng Liu & Daniel Waggoner & Tao Zha, 2009. "Asymmetric Expectation Effects of Regime Shifts in Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(2), pages 284-303, April.
    3. Yongsung Chang & Sun-Bin Kim & Frank Schorfheide, 2010. "Labor-Market Heterogeneity, Aggregation, and the Lucas Critique," RCER Working Papers 556, University of Rochester - Center for Economic Research (RCER).
    4. Carravetta, Francesco & Sorge, Marco M., 2013. "Model reference adaptive expectations in Markov-switching economies," Economic Modelling, Elsevier, vol. 32(C), pages 551-559.
    5. Ferman, Marcelo, 2011. "Switching Monetary Policy Regimes and the Nominal Term Structure," Dynare Working Papers 5, CEPREMAP.

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    More about this item

    Keywords

    Structural breaks; inflation persistence; macroeconomic volatility; expectations-formation mechanism; monetary policy regime;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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