Regime switches, Agents’ Beliefs, and Post-World War II U.S. Macroeconomic Dynamics

Bianchi, Francesco (2008): Regime switches, Agents’ Beliefs, and Post-World War II U.S. Macroeconomic Dynamics.

Abstract

The evolution of inflation and output over the last 50 years is examined through the lens of a micro-founded model that allows for changes in the behavior of the Federal Reserve and in the volatility of structural shocks. Agents are aware of the possibility of regime changes and their beliefs have an impact on the law of motion underlying the macroeconomy. The results support the view that there were regime switches in the conduct of monetary policy. However, the behavior of the Federal Reserve is identified by repeated fluctuations between a Hawk- and a Dove- regime, instead of by the traditional pre- and post- Volcker structure. Counterfactual simulations show that if agents had anticipated the appointment of an extremely conservative Chairman, inflation would not have reached the peaks of the late `70s and the inflation-output trade-off would have been less severe. These "beliefs counterfactuals" are new in the literature. Finally, the paper provides a Bayesian algorithm to handle the technical difficulties that arise in a rational expectations model with Markov-switching regimes.

• Item Type: MPRA Paper
• Language: English
• Keywords: Beliefs, Markov-switching, DSGE, Monetary Policy, Bayesian
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C11 - Bayesian Analysis: General

References

Benati, L. and Surico, P.: 2009, VAR analysis and the Great moderation, American Economic Review 99(4), 1636�52.

Bernanke, B.: 3 Feb 2003, Constrained Discretion and monetary policy, Remarks before Money Marketeers of New York University.

Bernanke, B. S. and Mihov, I.: 1998, Measuring monetary policy, Quarterly Journal of Economics 113(3), 862�902.