Monetary policy in a Markov-switching VECM: implications for the cost of disinflation and the price puzzle

Neville Francis and Michael Owyang

No 2003-001, Working Papers from Federal Reserve Bank of St. Louis

Abstract: Monetary policy VARs typically presume stability of the long-run outcomes. We introduce the possibility of switches in the long-run equilibrium in a cointegrated VAR by allowing both the covariance matrix and weighting matrix in the error-correction term to switch. We find that monetary policy alternates between sustaining long-run growth and disinflationary regimes. Allowing state changes can also help explain the price puzzle and justify the use of commodity prices as a corrective measure. Finally, we show that regime-switching has implications for disinflationary monetary policy and can explain the variety of sacrifice ratio estimates that exist in the literature.

Keywords: Monetary policy; Econometric models (search for similar items in EconPapers)
Date: 2004
New Economics Papers: this item is included in nep-ets and nep-mac
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Citations: View citations in EconPapers (8)

Published in Journal of Business and Economic Statistics, July 2005, 23(3), pp. 305-13

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