Time Consistent Policy in Markov Switching Models

Fabrizio Zampolli and Andrew Blake

No 134, Computing in Economics and Finance 2005 from Society for Computational Economics

Abstract: In this paper we consider the quadratic optimal control problem with regime shifts and forward-looking agents. This extends the results of Zampolli (2003) who considered models without forward-looking expectations. Two algorithms are presented: The first algorithm computes the solution of a rational expectation model with random parameters or regime shifts. The second algorithm computes the time-consistent policy and the resulting Nash-Stackelberg equilibrium. The formulation of the problem is of general form and allows for model uncertainty and incorporation of policymaker’s judgement. We apply these methods to compute the optimal (non-linear) monetary policy in a small open economy subject to (symmetric or asymmetric) risks of change in some of its key parameters such as inflation inertia, degree of exchange rate pass-through, elasticity of aggregate demand to interest rate, etc.. We normally find that the time-consistent response to risk is more cautious. Furthermore, the optimal response is in some cases non-monotonic as a function of uncertainty. We also simulate the model under assumptions that the policymaker and the private sector hold the same beliefs over the probabilities of the structural change and different beliefs (as well as different assumptions about the knowledge of each other’s reaction function).

Keywords: monetary policy; regime switching; model uncertainty; time consistency (search for similar items in EconPapers)
JEL-codes: D81 E52 (search for similar items in EconPapers)
Date: 2005-11-11
New Economics Papers: this item is included in nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
http://repec.org/sce2005/up.6985.1106827445.pdf (application/pdf)

Related works:
Working Paper: Time Consistent Policy in Markov Switching Models (2005)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:sce:scecf5:134

Access Statistics for this paper

More papers in Computing in Economics and Finance 2005 from Society for Computational Economics Contact information at EDIRC.
Bibliographic data for series maintained by Christopher F. Baum ().