Realised and Optimal Monetary Policy Rules in an Estimated Markov-Switching DSGE Model of the United Kingdom

Xiaoshan Chen and Ronald MacDonald

Working Papers from Business School - Economics, University of Glasgow

Abstract: This paper conducts a systematic investigation of parameter instability in a small open economy DSGE model of the UK economy over the past thirty-five years. Using Bayesian analysis, we find a number of Markov-switching versions of the model provide a better fit for the UK data than a model with time-invariant parameters. The Markov-switching DSGE model that has two independent Markov-chains - one governing the shifts in UK monetary policy and nominal price rigidity and one governing the standard deviations of shocks - is selected as the best fitting model. The preferred model is then used to evaluate and design monetary policy. For the latter, we use the Markov-Jump-Linear-Quadratic (MJLQ) model, as it incorporates abrupt changes in structural parameters into derivations of the optimal and arbitrary policy rules. It also reveals the entire forecasting distribution of the targeted variables. To our knowledge, this is the first paper that attempts to evaluate and design UK monetary policy based on an estimated open economy Markov-switching DSGE model.

Keywords: DSGE models; Markov-switching; Bayesian analysis (search for similar items in EconPapers)
JEL-codes: C11 C32 C51 C52 (search for similar items in EconPapers)
Date: 2011-01
New Economics Papers: this item is included in nep-cba, nep-dge, nep-for, nep-mac and nep-mon
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Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Realized and Optimal Monetary Policy Rules in an Estimated Markov-Switching DSGE Model of the United Kingdom (2012)
Working Paper: Realised and Optimal Monetary Policy Rules in an Estimated Markov-Switching DSGE Model of the United Kingdom (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:gla:glaewp:2011_04

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