Origins of monetary policy shifts: A New approach to regime switching in DSGE models

Abstract

We examine monetary policy shifts by taking a new approach to regime switching in a small scale monetary DSGE model with threshold-type switching in the monetary policy rule. The policy response to inflation is allowed to switch endogenously between two regimes, hawkish and dovish, depending on whether a latent regime factor crosses a threshold level. Endogeneity stems from the historical impacts of structural shocks driving the economy on the regime factor. We quantify the endogenous feedback from each structural shock to the regime factor to understand the sources of the observed policy shifts. This new channel sheds new light on the interaction between policy changes and measured economic behavior. We develop a computationally efficient filtering algorithm for state-space models with time-varying transition probabilities that handles classical regression models as a special case. We apply this filter to estimate our DSGE model using the U.S. data and find strong evidence of endogeneity in the monetary policy shifts.

Fiscal deficits and the socioeconomic consequences of rebalancing: Insights from a TVP‐VAR with stochastic volatility

“…We acknowledge the fact that Markov Switching Dynamic Regression models are popular in empirical analyses about fiscal policies. Nevertheless, we follow Chang, Choi, and Parka (2017); Chang, Maih, and Tan (2021), who show that the dynamics driving these models are governed by a regime switching process that is fundamentally exogenous and, as such, far from satisfactory to 'understand the nature of policymaking and its impact on economic phenomena' (Chang et al, 2021, p. 1). In contrast, the use of a TVP VAR guarantees the endogeneity of the dynamic processes here examined.…”