Monetary Policy, Financial Frictions and Structural Changes: A Markov-Switching DSGE Approach

Francis Anguyo, Rangan Gupta and Kevin Kotze
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Francis Anguyo: School of Economics, University of Cape Town, Rondebosch, South Africa

No 201748, Working Papers from University of Pretoria, Department of Economics

Abstract: This paper considers the use of regime-switching dynamic stochastic general equilibrium models for monetary policy analysis and forecasting purposes. The model incorporates financial frictions that are introduced through the activities of heterogeneous agents in the household and several other features that are incorporated in most small open-economy models. Two variants of regime-switching models are considered: one includes switching in the monetary policy rule (only) and the other employs switching in both the monetary policy rule and the volatility of the shocks. The models are applied to the quarterly macroeconomic data for Uganda and most of the parameters are estimated with the aid of Bayesian techniques. The results of the extensive in- and out-of-sample evaluation suggest that the model parameters do not remain constant over the two regimes. In addition, the transition probabilities suggest that the nature of the regime-switching is consistent with the existence of isolated pulse effects that relate to significant shocks which affected the Ugandan economy, rather than level shifts in the central bank policy rule. It is also noted that the forecasting performance of the regime-switching models is possibly superior to the model that excludes these features.

Keywords: Monetary policy; inflation-targeting; financial frictions; small open-economy; low income country; dynamic stochastic general equilibrium model; Bayesian estimation. (search for similar items in EconPapers)
JEL-codes: E32 E52 F41 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2017-06
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-ore
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Working Paper: Monetary Policy, Financial Frictions and Structural Changes: A Markov-Switching DSGE approach (2017)
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