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

40 Pages Posted: 15 Feb 2019 Last revised: 22 Feb 2021

See all articles by Yoosoon Chang

Yoosoon Chang

Indiana University Bloomington - Department of Economics

Junior Maih

Norges Bank

Fei Tan

Saint Louis University

Multiple version iconThere are 2 versions of this paper

Date Written: October 18, 2019

Abstract

This article studies the estimation of state space models whose parameters are switching endogenously between two regimes, depending on whether an autoregressive latent factor crosses some threshold level. Endogeneity stems from the sustained impacts of transition innovations on the latent factor, absent from which our model reduces to one with exogenous Markov switching. Due to the exible form of state space representation, this class of models is vastly broad, including classical regression models and the popular dynamic stochastic general equilibrium (DSGE) models as special cases. We develop a computationally efficient filtering algorithm to estimate the nonlinear model. Calculations are greatly simplified by appropriate augmentation of the transition equation and exploiting the conditionally linear and Gaussian structure. The algorithm is shown to be accurate in approximating both the likelihood function and filtered state variables. We also apply the filter to estimate a small-scale DSGE model with threshold-type switching in monetary policy rule, and find apparent empirical evidence of endogeneity in the U.S. monetary policy shifts. Overall, our approach provides a greater scope for understanding the complex interaction between regime switching and measured economic behavior.

Keywords: state space model; regime switching; endogenous feedback; filtering; DSGE model

JEL Classification: C13, C32, E52

Suggested Citation

Chang, Yoosoon and Maih, Junior and Tan, Fei, Origins of Monetary Policy Shifts: A New Approach to Regime Switching in DSGE Models (October 18, 2019). Norges Bank Working Paper 12/2018; ISBN 978-82-8379-059-7 , Available at SSRN: https://ssrn.com/abstract=3334920 or http://dx.doi.org/10.2139/ssrn.3334920

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

Fei Tan

Saint Louis University ( email )

3674 Lindell Boulevard
Saint Louis, MO 63108
United States

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