Monetary policy regime shifts and inflation persistence

Troy Davig and Taeyoung Doh

No RWP 08-16, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: This paper reports the results of estimating a Markov-Switching New Keynesian (MSNK) model using Bayesian methods. The broadest and best fitting MSNK model is a four-regime model allowing independent changes in the regimes governing monetary policy and the volatility of the shocks. We use the estimates to investigate the mechanisms that lead to a decline in the persistence of inflation. We show that the population moment describing the serial correlation of inflation is a weighted average of the autocorrelation parameters of the exogenous shocks. Changes in the monetary or shock volatility regimes shift weight over these serial correlation parameters and affect the serial correlation properties of inflation. Estimation results indicate that a shift to a monetary regime that reacts more aggressively to inflation reduces the weight on the more persistent shocks, so lowers inflation persistence. Similarly, a shift to the low-volatility regime reduces the weight on the more persistent shocks and also contributes to reducing inflation persistence. Estimates of model-implied inflation persistence indicate that it began rising in the late 1960s and peaked around the Volcker disinflation. The subsequent decline in persistence is due to both a more aggressive monetary policy regime and less volatile shocks.

Date: 2008
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Related works:
Journal Article: Monetary Policy Regime Shifts and Inflation Persistence (2014)
Working Paper: Monetary Policy Regime Shifts and Inflation Persistence (2009)
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