TIMING AND SIGNALS OF MONETARY REGIME SWITCHING

Daniel Soques

Macroeconomic Dynamics, 2022, vol. 26, issue 4, 885-919

Abstract: This study investigates if the reaction function of the Federal Reserve switches between two distinct policy rules. Using a time-varying transition probability framework, we also determine if forward-looking macroeconomic or financial covariates signal an impending monetary regime switch. We find that US monetary policy is best described by a Markov-switching model with two regime processes, one of which controls for heteroskedasticity in the shocks to the policy rule. We find that the Fed switches between an aggressive regime with a relatively high weight on inflation and a dovish regime that is less responsive to inflationary pressures. We find that an increase in private forecasters’ expectations of an impending recession signals a switch from the more aggressive policy regime to the less aggressive regime. A recovery in equity returns signals a return back to the more aggressive regime.

Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:cup:macdyn:v:26:y:2022:i:4:p:885-919_2

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