Asymmetric Expectation Effects of Regime Shifts and the Great Moderation

Zheng Liu, Daniel Waggoner and Tao Zha

No 1357, Kiel Working Papers from Kiel Institute for the World Economy (IfW Kiel)

Abstract: We assess the quantitative importance of expectation effects of regime shifts in monetary policy in a DSGE model that allows the monetary policy rule to switch between a ?bad? regime and a ?good? regime. When agents take into account such regime shifts in forming expectations, the expectation effect is asymmetric. In the good regime, the expectation effect is small despite agents' disbelief that the regime will last forever. In the bad regime, however, the expectation effect on equilibrium dynamics of inflation and output is quantitatively important, even if agents put a small probability that monetary policy will switch to the good regime. Although the expectation effect dampens aggregate fluctuations in the bad regime, a switch from the bad regime to the good regime can still substantially reduce the volatility of both inflation and output, provided that we allow some ?reduced-form? parameters in the private sector to change with monetary policy regime.

Keywords: Structural breaks; inflation persistence; macroeconomic volatility; expectations-formation mechanism; monetary policy regime (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Asymmetric expectation effects of regime shifts and the Great Moderation (2007)
Working Paper: Asymmetric expectation effects of regime shifts and the Great Moderation (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:ifwkwp:1357

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