Macroeconomic Switching Regimes and Monetary Policy in Canada

Ronald Henry Lange

Applied Economics and Finance, 2017, vol. 4, issue 4, 17-31

Abstract: This study examines the behaviour of monetary policy in Canada over the last 40 years using a Markov-switching VAR model of the macroeconomy. The Markov-switching estimates capture three continuous regimes that are interpreted as the ¡®surprise¡¯ regime from 1972Q1 to 1982Q2, the ¡®recovery¡¯ regime from 1982Q3 to 1991Q3 and the ¡®target¡¯ regime from 1991Q4 to 2014Q4. Monetary policy multipliers for the output gap are greater than one for all three regimes, suggesting that the central bank does not accommodate any expected changes in inflation over the long-run due to the domestic relationship between the output gap and future inflation. The long-run multipliers for inflation are equal to one in the surprise and recovery regimes, indicating that monetary policy also responds to offset inflation shocks. Overall, the policy multipliers and impulse response functions indicate a proactive central bank that responds systematically to movements in the output gap in order to control expected future inflation and to inflation surprises in the three regimes. The regime-dependent behaviour of monetary policy indicates a central bank pursuing an implicit form of inflation targeting as a means of achieving a nominal anchor for policy. The implicit inflation tar-gets are consistent with historical episodes of inflation in Canada over the past 40 years.

Keywords: monetary policy; policy multipliers; inflation targets; regime switching; vector autoregessions (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:rfa:aefjnl:v:4:y:2017:i:4:p:17-31

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