Origins of Monetary Policy Shifts: A New Approach to Regime Switching in DSGE Models

CAEPR Working Paper Series 2018-011

41 Pages Posted: 16 Dec 2018 Last revised: 4 Mar 2021

See all articles by Yoosoon Chang

Yoosoon Chang

Indiana University Bloomington - Department of Economics

Junior Maih

Norges Bank

Tan Fei

Zhejiang University - College of Economics; Indiana University

Multiple version iconThere are 2 versions of this paper

Date Written: February 17, 2021

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.

Keywords: Monetary policy, DSGE model, regime switching, latent autoregressive regime factor, endogenous feedback, expectation formation effects

JEL Classification: E52, C13, C32

Suggested Citation

Chang, Yoosoon and Maih, Junior and Fei, Tan, Origins of Monetary Policy Shifts: A New Approach to Regime Switching in DSGE Models (February 17, 2021). CAEPR Working Paper Series 2018-011, Available at SSRN: https://ssrn.com/abstract=3290704 or http://dx.doi.org/10.2139/ssrn.3290704

Yoosoon Chang (Contact Author)

Indiana University Bloomington - Department of Economics ( email )

Wylie Hall
Bloomington, IN 47405-6620
United States

Junior Maih

Norges Bank ( email )

P.O. Box 1179
Oslo, N-0107
Norway

Tan Fei

Zhejiang University - College of Economics ( email )

Yuquan Campus 38 Zheda Road
Hangzhou, Zhejiang 310027
China

Indiana University ( email )

107 S Indiana Ave
100 South Woodlawn
Bloomington, IN 47405
United States

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