Taylor-type rules versus optimal policy in a Markov-switching economy¤

Fernando Alexandre (), Pedro Bação and Vasco J. Gabriel

No 608, Department of Economics Discussion Papers from Department of Economics, University of Surrey

Abstract: We analyse the e®ect of uncertainty concerning the state and the nature of asset price movements on the optimal monetary policy response. Uncertainty is modelled by adding Markov-switching shocks to a DSGE model with capital accumulation. In our analysis we consider both Taylor-type rules and optimal policy. Taylor rules have been shown to provide a good description of US monetary policy. Deviations from its implied interest rates have been associated with risks of ¯nancial disruptions. Whereas interest rates in Taylor-type rules respond to a small subset of information, optimal policy considers all state variables and shocks. Our results suggest that, when a bubble bursts, the Taylor rule fails to achieve a soft landing, contrary to the optimal policy.

Keywords: Asset Prices; Monetary Policy; Markov Switching. (search for similar items in EconPapers)
JEL-codes: E52 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2008-06
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Related works:
Working Paper: Taylor-type rules versus optimal policy in a Markov-switching economy (2008)
Working Paper: Taylor-type rules versus optimal policy in a Markov-switching economy (2008)
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Persistent link: http://EconPapers.repec.org/RePEc:sur:surrec:0608

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