Minimal state variable solutions to Markov-switching rational expectations models

Roger Farmer, Daniel Waggoner and Tao Zha

No 2008-23, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

Abstract: We develop a new method for computing minimal state variable solutions (MSV) to Markov-switching rational expectations models. We provide an algorithm to compute an MSV solution and show how to test a given solution for uniqueness and boundedness. We construct an example that is calibrated to U.S. data and show that the MSV solution in our example is unique. This solution can potentially explain in three different ways the observed reduction in the variance of inflation and the interest rate after 1980: The policy rule might have changed, the variance of the fundamental shocks might have fallen, or the private sector equations might have been different across regimes. We compare these three explanations for the change in variance and show that any one of them can potentially account for the facts. Our paper provides the necessary tools for a future empirical study of this issue.

Keywords: Econometric; models (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-cba
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Citations: View citations in EconPapers (62)

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Journal Article: Minimal state variable solutions to Markov-switching rational expectations models (2011)
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