Monetary Regime Change and Business Cycles

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractThis 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 dynamic stochastic general equilibrium (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 present 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.

Financial Frictions, Financial Shocks, and Aggregate Volatility

“…This paper contributes to the debate about the sources of the Great Moderation by analyzing jointly the role of shocks, the conduct of monetary policy, and financial rigidities in the demand of capital. This paper also contributes to the literature by documenting the increase in financial volatilities in the U.S. corporate sector and extending the novel estimation methodology of Cúrdia and Finocchiaro (2013) .…”

“…To test the role of institutional change and changes in the size of exogenous shocks in accounting for the divergent patterns in cyclical volatilities, we estimate the model subject to structural breaks in the monetary policy coefficients, the size of the financial rigidity at the steady state, and the size of shocks. Our econometric approach generalizes the work of Cúrdia and Finocchiaro (2013) by incorporating steady-state parameters in the set of parameters subject to structural breaks. Unlike many articles in the literature, we conclude that there was no unique driver of the Great Moderation.…”

Financial Frictions, Financial Shocks, and Aggregate Volatility

“…allow for breaks in three subsets of parameters: size of shocks, monetary policy coefficients, and the unconditional mean of the marginal bankruptcy cost, which characterizes the financial system 7 . Following Cúrdia and Finocchiaro (2013), I impose the dating of the structural breaks in a subset of parameters but I do not allow economic agents to form expectations about them. These simplifications allow me to proceed within the log-linear framework using small departures in generating the posterior.…”

“…These simplifications allow me to proceed within the log-linear framework using small departures in generating the posterior. As in Cúrdia and Finocchiaro (2013), I compute separate equilibria for the same model with only a subset of regime-dependent equations changed and reconnect the rational expectations equilibria via the likelihood function. In this way, a computational bridge can be established between subsamples so that the entire sample can be used to estimate parameters that are constant across regimes and 7 Allowing for breaks in only one of the parameters characterizing the financial accelerator may seem too simplistic despite being the parameter that conceptually measures the size of the financial rigidity.…”

“…proceed with the joint estimation of the regimes. Cúrdia and Finocchiaro (2013) develop their approach to estimation for an open economy model with breaks only in the monetary policy coefficients. In this paper, I generalize their estimation method to environments with breaks in parameters governing the steady state of the model economy, which requires to ensure that the econometrician is using the same information set as the economic agent when conducting the estimation exercise.…”